Industrials / China 9 January 2015

Initiation: rail plays to benefit China Railway Sector from urbanisation, overseas push Positive (initiation) • Railway construction and equipment companies stand to benefit Neutral from ongoing investment in HSR and urban rail transit market Negative • Zhuzhou CSR should be key beneficiary of CSR/CNR merger,

increasing its market share substantially without paying the price • Our order of preference: Zhuzhou CSR , CSR, CRG, CRCC, CCCC How do we justify our view?

urbanisation rate in China, and [3]) has less exposure to railway believe the urban transit market will construction. Local governments’ be a long-term earnings and share- high debt levels and weak land sales price driver for the sector. With could drag down investments in road China’s government’s aggressive and port projects to which CCCC has Brian Lam plans for SOEs to strengthen their high exposure. (852) 2532 4341 overseas businesses, we believe both [email protected] railway constructors and equipment ■ Catalysts makers will benefit handsomely by The 13th FYP is expected to be Kelvin Lau increasing their international announced in 3Q15.We estimate total (852) 2848 4467 presence, given their competitive railway FAI for 13th FYP to be greater [email protected] advantage in providing quality than that for 12th FYP. Better-than-

products at a low cost. expected 2014 results and railway ■ Investment case FAI target for 2015E could be a near- ■ Recommendation We initiate coverage of the China term catalyst. Railway Construction and Railway We prefer the railway equipment ■ Risks Equipment Sector with a Positive makers over the railway constructors, rating. Our view is based on: 1) as we see greater visibility on demand Key risks: 1) unexpected disruptions positive railway investment for rolling stock going forward. We in overseas markets, 2) regulatory supported by favourable government believe Zhuzhou CSR will benefit the risk affecting the FAI target at home, policy, 2) the long-term growth most from the pending merger of and 3) equipment makers delivering potential for the urban rail transit CSR Corp and CNR Corp (6199 HK, railway products later than expected. market, which will benefit from Not Rated), as it will be able to Key stock calls China’s increasing urbanisation, and provide train components to CNR, as 3) overseas market expansion, with well as MU components to CSR. We New Prev. also like CSR due to its high backlog Zhuzhou CSR Times Electric (3898 HK) support from the China government. Rating Buy coverage. These companies should all benefit from this merger through Target 58.00 We forecast total railway FAI to rise Upside  29.9% by 20% YoY to CNY800bn for 2014; reduced costs and competition. CSR Corp (1766 HK) and on the back of this high base, we Rating Buy Our top picks in order of preference see total railway FAI growth of 4% Target 13.30 YoY for both 2015 (to CNY830bn) are: Zhuzhou CSR (3898 HK, Upside  29.4% and 2016 (to CNY860bn). China HKD44.65, Buy [1]) and CSR (1766 China Railway Group (390 HK) railway constructors and railway HK, HKD10.28, Buy [1]). We are also Rating Buy equipment makers, whose revenue positive on China Railway Group Target 7.50 Upside  21.6% growth has in the past been closely (CRG) (390 HK, HKD6.17, Buy [1]) for its high exposure to the urban rail China Railway Construction (1186 HK) correlated with railway FAI, are the Rating Buy immediate beneficiaries of China’s transit market. We rate China Railway Construction (CRCC) Target 11.70 FAI boom. We expect investment Upside  20.2% sentiment toward the sector upcycle (1186 HK, HKD9.73, Buy [1]) for its higher exposure and experience in China Communications Construction (1800 HK) to strengthen over this year. We are Rating Hold overseas markets, while China also positive on China’s urban transit Target 9.30 rail market because of the increasing Communications Construction Downside  3.7% (CCCC) (1800 HK, HKD9.66, Hold Source: Daiwa forecasts.

See important disclosures, including any required research certifications, beginning on page 80 China Railway Sector 9 January 2015

Sector stocks: key indicators

EPS (local curr.) Share Rating Target price (local curr.) FY1 FY2 Company Name Stock code Price New Prev. New Prev. % chg New Prev. % chg New Prev. % chg China Communications Construction 1800 HK 9.66 Hold 9.30 0.797 0.874 China Railway Construction 1186 HK 9.73 Buy 11.70 0.935 0.898 China Railway Group 390 HK 6.17 Buy 7.50 0.519 0.579 CSR Corp 1766 HK 10.28 Buy 13.30 0.422 0.485 Zhuzhou CSR Times Electric 3898 HK 44.65 Buy 58.00 1.975 2.192 Source: Daiwa forecasts

- 2 - China Railway Sector 9 January 2015

Contents

Riding on the upcycle in infrastructure FAI ...... 4 Railway FAI remains China’s most favourable way of stabilising economic growth ...... 4 Extending the existing railway network – cargo transportation and connections to western China ...... 6 No concern about the CRC’s funding of railway investment ...... 9 Urban rail transit – benefiting from urbanisation in China ...... 11 China’s aggressive plan: urbanisation rate of 60% by 2020 ...... 11 Robust growth in investment in urban rail transit systems ...... 11 Strong support from government to develop urban rail transit ...... 14 Robust revenue growth overseas, but may come at a price ...... 15 China aggressively promoting HSR products to the world ...... 15 Competitive edge of China’s HSR constructors over overseas peers ...... 16 Overseas: big markets with good growth potential, but at a price ...... 17 “One belt one road” policy ...... 17 CSR/CNR: merging to avoid direct overseas competition ...... 18 Competitive advantage of the China railway equipment players over overseas peers ...... 19 CSR vs. CNR: how do they differ in terms of technology? ...... 19 Key stock calls ...... 20 Buy rolling-stock manufacturers ...... 20 Risk to our calls ...... 22 Appendix ...... 26 Types of rolling stock ...... 26

Company Section Zhuzhou CSR Times Electric ...... 29 CSR Corp ...... 38 China Railway Group ...... 50 China Railway Construction ...... 59 China Communications Construction ...... 69

- 3 - China Railway Sector 9 January 2015

Railway investment stands out among other infrastructure segments Among the sub segments of the infrastructure sector, railway investment stands out, as most other infrastructure segments have different issues that Riding on the upcycle restrain the central government from placing large investment. For example, highway and waterway in infrastructure FAI projects are typically funded by local governments and private investors. Given local governments’ high debt levels currently, it is unlikely they would put significant China’s railway constructors and capital into highway and waterway investment, in our equipment makers look set to benefit from view. On the other hand, airport investment is so small the FAI boom in the country. We are in scale it is of limited help to economic growth. bullish on the urban rail transit segment  Local government debt levels which is benefiting from China’s (CNYbn) urbanisation trend, and believe overseas 20,000 70% business expansion is also a highlight. 60% 15,000 50% 40% 10,000 Railway FAI remains China’s 30% most favourable way of 5,000 20% stabilising economic growth 10% 0 0% 2008 2009 2010 2011 2012 2013 High railway investment needed to sustain Local government debt oustanding YoY Growth %

China’s economic growth Source: CEIC, Daiwa We believe railway investment will continue to be the Chinese government’s most favourable way of Railway FAI was raised 3 times in 2014; sustaining the country’s economic growth, given its will history repeat itself? significance in infrastructure spending. As such, we China’s railway FAI target was raised a total of 3 times forecast total railway FAI to grow by a strong 20% YoY in 2014 to support economic growth. In early 2014, the to CNY800bn for 2014, and by 4% YoY for each of 2015 China Railway Corporation (CRC), which operates and 2016, to CNY830bn and CNY860bn, respectively. China’s rail network, announced total railway FAI of CNY630bn, which was subsequently raised to  China: railway FAI forecasts CNY700bn, then to CNY720bn, and ultimately set at (CNYm) CNY800bn on 30 April 2014. 1,000,000

800,000 The CRC is due to announce its railway FAI target for 2015 soon. If the initial railway FAI target is less than 600,000 the CNY800bn FAI in 2014, and the market responds negatively, we would see a good buying opportunity, as 400,000 the CRC would be likely to revise up its target later in 200,000 the year in order to stabilise economic growth.

0 Daiwa’s economics team forecasts China’s GDP to rise 2012 2013 2014E 2015E 2016E by 6.9% YoY for 2015 and its FAI to increase by 14.5% Railway Infrastructure Investment Train purchase investment Upgrade and Maintenance YoY. The infrastructure and property construction Source: CRC, Daiwa forecasts sectors are both policy-driven and heavily dependent on government plans, and together account for about half of China’s total FAI spending. We believe continuous development of railway FAI will be needed to support the country’s economic growth, given the sluggish investments in other infrastructure sub sectors. Major sectors like property, domestic - 4 - China Railway Sector 9 January 2015

consumption and exports are not holding up well Back-end-loaded 12th FYP, front-end- either. Therefore, we believe railway investment will loaded 13th FYP play an important role in stabilising China’s economic According to the 12th FYP plan, China should achieve a growth in 2015. total of 120,000km regular railway mileage by the end of 2015. We estimate there was 110,600km of regular  China: FAI breakdown in 2014 railway mileage operating in China by the end of 2014. Others To achieve the target in the 12th FYP, China needs to Resources 5.5% Infrastructure roll out about 9,400km of new railway projects in 2015 11.3% 23.3% versus 7,000km of new mileage in 2014, which means total railway investment for 2015 should be greater than the CNY800bn invested in 2014. As such, we forecast total railway investment of CNY830bn for th Manufacturing 2015 and CNY860bn for 2016. Unlike in the 12 FYP, 25.1% when most of the FAI was back-end loaded, we believe th Property and the upcoming 13 FYP will be front-end loaded, Construction echoing the CRC’s plan in 2014 to approve and start 64 Service 25.9% new railway projects. 9.0%

Source: CEIC, Daiwa  China: regular railway operating mileage

(km)  China: railway infrastructure investment 140,000 (CNYm) 800,000 30% 120,000 700,000 20% 100,000 600,000 10% 80,000 500,000 0% 400,000 60,000 (10%) 300,000 40,000 200,000 (20%) 100,000 (30%) 20,000 0 (40%) 0 2010 2011 2012 2013 2014E 2015E 2016E 2011 2012 2013 2014E 2015E Railway Infrastructure Investment (LHS) YoY Growth % (RHS) Source: CRC, Daiwa forecasts

Source: CRC, Daiwa forecasts  China: high speed railway operating mileage  China: railway equipment investment (km) (CNYm) 30,000 250,000 40% 25,000 200,000 30% 20,000 20% 150,000 15,000 10% 100,000 0% 10,000 50,000 (10%) 5,000 0 (20%) 2010 2011 2012 2013 2014E 2015E 2016E 0 2011 2012 2013 2014E 2015E Railway Equipment Investment (LHS) YoY Growth % (RHS) Source: CRC, Daiwa forecasts Source: CRC, Daiwa forecasts Historically, actual spending in the FYP has been

generally 30%+ higher than that announced in the th original plan. For example, during the 11 FYP, the original target investment on railways was CNY1.75tn, while actual spending turned out to be CNY2.43tn. We

forecast CNY3.5tn in total railway investment for the 12th FYP, about 25% higher than the original plan of CNY2.8tn.

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 Historical FYP original target vs. actual investment Also, current coal transportation from the mines in (CNYm) northern China still relies on shipping from northern 4,000 ports to central and southern China. According to the 3,500 CRC, it plans to construct new railway lines for 3,000 transporting coal from north to south. One of the major 2,500 routes would be connecting Inner Mongolia to Jiangxi. 2,000 1,500 We believe more use of rail for coal transport will be 1,000 the future trend in China, and with the inability of the 500 new high-speed rail (HSR) to absorb much passenger 0 traffic from the regular railways (due to the high ticket 10th FYP 11th FYP 12th FYP price on the HSR), and hence free up rail lines for cargo Railway FAI - Original Target Railway FAI - Actual/Expected Investment use, China now faces a pressing need to build more Source: NDRC, CRC, Daiwa railway lines.

In the longer term, we believe the under-use of the new Extending the existing railway HSR may not be resolved any time soon, as we see network – cargo transportation more upside for current HSR fares in the long term due and connections to western China to the need to cover its high construction cost. As such, we see a chance of a fare increase on key routes, like Beijing-Shanghai. Moreover, we believe the There are still bottlenecks in railway transportation in government will reduce the subsidies on the HSR and China, especially in 2 areas: cargo transportation plans to move to more market-driven pricing. (especially for commodities like coal) and connections to western China.

Currently, even though the coal transportation network has been established for a long time in northern China, capacity is still insufficient to accommodate the strong demand in China. In our view, more railway lines are needed to penetrate further into various new mining areas.

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 Map of coal transportation network (2014)

Source: Daiwa

Appart from coal transportation, we see room for furrtther Therefore, we expect the development of western China development of the country’s railway network to to be one of the earnings driivers for the railway weestern China. Currently, the density of rail networrkks construction companies during the 13th FYP, especially is still focused oon coastal and central China, where given that contracts would be of a higher value due to most of the nation’s economic development is takinng the similar margins to consttruction in eastern China, place. However, with the continuous economic but with higher construction costs, as weestern China development of western China, the government plans has more mountainous areas that need additional to extend the railway network to western China to railway tunnels and bridges.. support development there.

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 Map of China’s railway network (2014)

Source: Daiwa

Many more HSR lines to be laid in 2014-20 For the 12th FYP, China plans to build a total of 19,000km of HSR lines. Even though the main HSR routes (4 vertical and 4 horizontal, according to the HSR development plan) were completed in 2013, there are still a number of HSR projects outstanding which connect routes to and from tier-1 cities to tier-2 and tier-3 cities. On our estimates, there is still 14,545km of HSR lines to be launched from 2014-20, which translates into CNY1.8tn of investment.

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 China: details of HSR construction plan (2014-20) Distance FAI Estimate completion No concern about the CRC’s Project (km) (CNYbn) date Nanjing-Qidong 284 35.2 2014 funding of railway investment Jiangyou-Meishan 314 38.9 2014 Qiangdao-Weishai-Rongcheng 299 37.1 2015 Zhengzhou - Xuzhou Railway 362 46.0 2015 High gearing ratio of the CRC Harbin-Qiqihar 286 31.2 2015 As mentioned, highway and waterway projects are Kunming - Nanning Railway 710 89.9 2015 mainly funded by local governments. However, Datong-Xi'an 859 96.3 2015 Changsha-Yiyang-Changde 170 21.8 2016 investment in such projects has been sluggish over the Meizhou-Shantou 116 13.6 2016 past 2 years, due mainly to the high debt levels of local East Guangdong coastal area inter-city 474 50.5 2017 governments. Baoji - Lanzhou Railway 401 64.7 2017 Beijing-Zhangjiakou 169 30.0 2017 Some investors would argue that this is the case for Changsha-Kunming 1,175 160.9 2018 Xuzhou-Suqian-Huaian-Yangzhou 300 37.1 2018 railway construction too, since the CRC also has a high Xi'an Jiangyou 519 64.3 2018 gearing ratio (the company recorded a net debt to South-Sichuan intercity 100 11.0 2018 equity ratio of 142% at the end of 3Q14, from 96% in Beijing-Tangshan 150 18.6 2018 2010). Jinan-Qingdao 363 44.9 2018 Beijing-Shenyang 697 124.5 2019 Xi'an-Chongqing 600 74.3 2019 However, in our view, the CRC’s high gearing is not a Harbin-Mudanjiang 290 35.9 2019 concern – at least in the near term. China Railway Corp Shangqiu-Heifei-Hangzhou 770 84.3 2020 (the successor to the Ministry of Railways), the Nantong-Suzhou-Jianxing 195 24.1 2020 country’s biggest railway constructor, reports directly Chongqin-Wanzhou 248 31.2 2020 Zhenzhou-Wanzhou 770 95.3 2020 to the central government. As such, railway Lianyungang-Yangzhou 311 40.0 2020 construction planning is made to comply with the Beijing-Tongliao 804 99.6 2020 central government’s nationwide strategy development. Yinchuan-Xi'an 599 74.2 2020 Harbin-Jiamsui 345 42.7 2020 Hangzhou-Guangzhou On the contrary, the construction of highways and (Guangdong section) 245 27.8 2020 waterways is funded by local governments, and Jiuzhou-Jingdezhen-Quzhou 333 29.5 2020 therefore constructors’ earnings and cash flow depend Chonqing-Kunming 700 86.7 2020 heavily on local government funding sources and Pan Asia Railway (Yunnan section) 600 74.3 2020 Pan Asia Railway (Guangxi section) 350 43.3 2020 economic targets. 14,545 1,835 Source: CEIC, compiled by Daiwa  CRC: net debt/equity ratio 150% 142.3%  China: HSR map 140% 135.9%

98 cities with HSR in operation 130% 124.7% 131 Cities with an HSR plan 92 Cities without any HSR plan 120% 111.3% 110%

Datong 100% 96.0%

90% 2010 2011 2012 2013 1-3Q14 Source: CRC, Daiwa

Source: Daiwa

- 9 - China Railway Sector 9 January 2015

 CRC: revenue breakdown  CRC: issuance of railway bonds and notes in 2014 (CNYm) Amount Date Years Rate (CNYbn) 700,000 2014 1st Railway Bond 11/04/14 10 5.78% 20 600,000 2014 2nd Railway Bond 14/05/14 10 5.26% 15 14/05/14 20 5.40% 5 500,000 2014 3rd Railway Bond 27/05/14 10 5.42% 15 400,000 27/05/14 20 5.51% 5 300,000 2014 4th Railway Bond 16/06/14 10 5.26% 15 2014 5th Railway Bond 07/07/14 10 5.40% 15 200,000 2014 6th Railway Bond 21/08/14 7 5.18% 15 100,000 2014 7th Railway Bond 12/09/14 7 5.18% 15 0 2014 8th Railway Bond 17/10/14 10 4.88% 15 2010 2011 2012 2013 1-3Q14 Issuance of Note Cargo Passenger Others 2014 1st mid-term note 23/04/14 5 5.70% 20 Source: CRC, Daiwa 2014 2nd mid-term note 24/10/14 5 4.73% 10 Total 165 CRC’s sources of funding Source: CRC, Daiwa

China’s government set up the Railway Development Fund in September 2014 to attract private investment into the railway sector. According to the guidelines, the fund serves as a market entity for railway investment and financing. The CRC represents government investments and is responsible for the daily management of the fund.

The government targets to raise around CNY200- 300bn for the fund, which will include CNY75bn from the central government, railway construction tax and other fiscal funding for railways, while the rest is to be raised from the public.

We believe the CRC’s future railway projects will be funded through the issuance of railway bonds to the tune of about CNY150bn, as well as via the Railway Development Fund of CNY200-300bn. The shortfall in funding will be fulfilled by bank borrowings since the return on investment in railways is not that high, and it can take a long time to break even, making it harder for railway projects to attract private investors.

 CRC: railway projects funding

Railway bonds 18.8%

Bank loans 48.1% Railway Development Fund 25.0%

Mid-term bills Financial 3.8% subsidy 4.4%

Source: CRC, Daiwa

- 10 - China Railway Sector 9 January 2015

200,000 residents by 2020. Civil aviation services will cover about 90% of China’s population by then.

Robust growth in investment in Urban rail transit – urban rail transit systems benefiting from According to the China Association of Metros, at the end of 2013 subways accounted for 75.5% of the total urbanisation in China length of China’s urban transit rail, followed by light rail, at 8.5%. At the end of 2013, China had a total of 2,746km of urban rapid transit lines. The CCID On the back of this urbanisation trend, we Consulting estimates that the typical investment in expect growing demand for urban rail China for a subway is about CNY500-700m/km, and that for a light rail is about CNY130-240m/km. transit systems and forecast a CAGR of 13% for urban rail transit investment Total investment in urban rail transit systems in China over 2014-18E. for 2014 was about CNY294bn, and should grow by 24% and 13%, to CNY365bn and CNY411bn for 2015E and 2016E, respectively, according to estimates from China’s aggressive plan: CCID Consulting. China’s urban rail transit system covered a total of about 3,101km as at the end of 2014, urbanisation rate of 60% by 2020 and CCID expects this to increase to 6,341km by the end of 2018, representing a CAGR of 20% over 2014-18E. The State Council released its New Urbanization Plan in 2014, the first of its kind, aiming to set out basic  China: types of urban transit rail principles, objectives and milestones for the country’s Urban rail rapid urbanisation plan from now to 2020. According to the Maglev system transit 1.1% 8.3% plan, China aims to increase its urbanisation ratio to Modern tram 60% by 2020, from 54% in 2013, by requiring around 3.9% 100m rural residents to migrate to urban areas. Monorail 2.7% Light rail  China: urbanisation rate – aiming for 60% by 2020 8.5% 65% 60% 59% 58% 60% 57% 56% 56% 55% 54% Subway 55% 53% 75.5%

51% 50% Source: China Association of Metros, Daiwa 50% 48% 47% 46% 44% 45% 43% The NDRC has approved urban rail transit projects for up to 38 cities, but has yet to start construction, while 40% projects for 43 other cities have either started or been completed. The total length of the urban rail transit network, if completed as scheduled, should reach more

Source: National Bureau of Statistics, Daiwa forecasts than 13,000km by 2020.

As a result of China’s urbanisation speeding up, we expect a substantial amount of FAI to be put into the construction of urban infrastructure and transport systems, including the urban rail transit market. According to the plan, regular railways will connect all cities with more than 200,000 residents by 2020, and the HSR will connect cities with more than 500,000 residents. Expressways will link cities with over

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 China: length of the urban rail transit system China cities: low urban rail transit density (km) Shanghai and Beijing currently have 2 of the largest 7,000 urban transit systems in China in terms of line length. Representing 6,000 +20% CAGR However, the density of urban rail transit (defined by 5,000 the operating length of the urban rail transit in a city divided by the total area of the city) in these 2 cities is 4,000 significantly lower than that for other major foreign 3,000 cities, like Tokyo, New York and London (see chart 2,000 below). 1,000 Some of China’s tier-2/3 cities do not have urban 0 2008 2009 2010 2011 2012 2013 2014E 2015E 2016E 2017E 2018E transit systems or have systems that have extremely

low density. However, given China’s increasing Source: China Association of Metros, CCID Consulting, Daiwa urbanisation rate, we see strong demand for urban rail

 China: investment in urban rail transit transits in the tier-2/3 cities, especially those with high populations. (Rmb bn) 600 Representing  Urban rail transit density for major cities across the globe (2013) +13% CAGR 500 (km/km2) 0.60 400 0.50 300 0.40 200 0.30

100 0.20 0.10 0 2008 2009 2010 2011 2012 2013 2014E 2015E 2016E 2017E 2018E 0.00

Source: China Association of Metros, CCID Consulting, Daiwa

Construction costs for a typical urban rail transit project in China account for the largest proportion of Source: CCID Consulting total investment, at about 40%, while vehicle procurement comprises around 10%.

 China: breakdown of capital expenditure for a typical urban rail transit project Preliminary Others planning and 10.0% design Interest of loans 6.0% 5.0% Relocation 9.0%

Equipment procurement 20.0%

Construction Vehicle 40.0% procurement 10.0% Source: CCID Consulting

- 12 - China Railway Sector 9 January 2015

 China: list of approved subway projects Approval of projects Length (km) Investment (CNYbn) Cost per km (CNYm) Completion Funding source Chengdu/no.1 ext 5 4 807 2015 25% local government + loan Qingdao/no. 2 25 18 697 Jan-16 35% local government + loan Shenzhen/no. 7 30 17 581 2017 50% local government + loan + property Shenzhen/no. 11 51 23 448 2016 50% local government + loan + property Suzhou/no. 2 ext 16 10 635 2016 35% local government + loan Guangzhou metro no. 3 North Extension 1 N/A N/A 2018 N/A Guangzhou metro no.4 line South extension 12 5 455.5 2017 45% local government + loan Guangzhou metro no.6 line phase 2 18 9 518.5 2015 60% local government + loan Guangzhou/no.7 31 9 307 2017 39.7% local government + loan Guangzhou metro no.8 line phase 3 15 11 738.4 2016 60% local government + loan Guangzhou metro Guangfo line 18 4 223.2 2016 43% local government + loan Guangzhou metro no. 9 line phase 1 20 N/A N/A 2015 N/A Guangzhou metro no.11 line 42 34 792.6 2018 45% local government + loan Guangzhou metro no.13 line phase1 28 18 644.4 2016 45% local government + loan Guangzhou metro no.14 sub-line 22 8 361.2 2017 45% local government + loan Guangzhou metro no.14 line phase1 51 19 369.4 2017 45% local government + loan Guangzhou metro no.21 line 59 29 496.3 2017 45% local government + loan Ningbo/no.1 46 21 443 Phase I by 2014 May, Phase II by 2015 25% local government + loan Tianjin/no.5 34 26 769 2016 50% local government + loan Tianjin/no. 6 56 40 710 2017 50% local government + loan Xi'an/no. 3 51 18 360 Phase I by 2015 30% local government + loan Changchun/no.2 21 13 626 2016 25% local government + loan Chengdu/no.3 20 11 575 2015 25% local government + loan Shijiazhuang metro no.1 line phase1 23.9 17.3 724 Jun-17 40% local government + loan Shijiazhuang metro no.2 line phase1 16.2 11.5 711 2020 40% local government + loan Shijiazhuang metro no.3 line phase1 19.5 14.0 716 Sep-15 40% local government + loan Taiyuan metro no.1 line phase1 36 16 441 2018 35% local government + loan Taiyuan metro no.2 line phase1 35 15 438 2016 35% local government + loan Lanzhou metro no.1 line phase1 34 20 588 2016 27.5% local government + loan Lanzhou metro no.2 line phase1 9 6 613 2020 27.5% local government + loan Shanghai metro no. 11 line Disney land section 9 4 478 2015 42% local government + loan Shanghai metro no. 8 line phase3 7 3 505 2015 42% local government + loan Shanghai metro no. 10 line phase2 10 7 738.5 2017 42% local government + loan Shanghai metro no. 3&4 line reform 3 3 1,111.2 2015 42% local government + loan Shanghai metro no. 17 line 35 18 507.8 2017 42% local government + loan Harbin metro no.1 line phase3 9 5 573.8 2019 40.8% local government + loan Harbin metro no.2 line North Extension 28 17 607.1 2018 40.8% local government + loan Approval of construction blueprint Shanghai 171 N/A N/A N/A 42% local government + loan Guangzhou 70 N/A N/A N/A 45% local government + loan Harbin 257 24 581 N/A 40.8% local government + loan Shenyang 119 61 1,681 N/A 30% local government + loan Xiamen 75 50 669 N/A 40% local government + loan Changzhou 54 34 625 N/A 40% local government + loan Total 1,690 674 399 Source: NDRC, Daiwa

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 China: major construction plans for subways Length (km) 2005 2008 2009 2010 2011 2012 2015E 2020E Shanghai 106 263 343415 517 530 6151,172 Beijing 115 200 228336 389 516 6601,000 Guangzhou 37 117 150236 243 260 310600 Shenzhen 22 22 2299 130 178 246597 Tianjin 26 71 79140 140 140 170470 Chongqing 19 19 1924 76 120 180354 Nanjing 22 22 2285 85 85 280380 Wuhan 10 10 2929 58 74 90238 Hangzhou - - -- 48 48 78285 Dalian - 49 4949 88 88 122193 Changchun - 31 3148 48 48 94257 Shenyang - - -28 47 47 122189 Chengdu - - -16 16 39 147292 Suzhou - - -- 26 26 117180 Harbin - - -- - 14 1446 Ningbo ------21248 Hefei ------56181 Zhengzhou ------4596 Foshan - - -19 19 19 73128 Xiamen ------97 Xi'an - - -- 21 21 88117 Qingdao ------2887 Kunming ------42162 Dongguan ------59122 Wuxi ------56100 Nanchang ------3570 Fuzhou ------2955 Changsha ------42116 Urumqi ------2453 Nanning ------5293 Guiyang ------56139 Changzhou ------54 Taiyuan ------49116 Lanzhou ------2337 Quanzhou ------73 Wenzhou ------80 Xuzhou ------32100 Shijiazhuang ------1854 Total 357 804 9721,518 1,959 2,341 4,073 8,707 Source: Various news reports, Daiwa

road. Urban transit railways are considered by the Strong support from government government as one of the most effective ways to ease to develop urban rail transit traffic congestion, given their large passenger capacity and the high speed at which they can deliver China announced a series of policies in 2012 and 2013 passengers to their destinations. to enhance the development of urban rail transit during the period of the 12th Five Year Plan (FYP) Electricity-powered rail transit systems can also benefit (2011-15), including the Opinions of the State Council society by creating less pollution and noise, as well as on Strengthening Urban Infrastructure Construction promoting energy savings and efficiency. The (the Opinion) in 2013 to promote the construction of construction of urban rail transit systems also subways and light rail. By the end of 2015, the length of facilitates the development of areas along the rail lines, the urban rail transit in operation in China will need to which increases the value of the land and overall increase by 1,000km from 2013, according to the competitiveness of the cities. As such, we would expect Opinion. local governments to strongly support the development of urban rail transit systems in China. We see a pressing need for local governments to solve the traffic congestion and air pollution problems across the country. As a result of China’s rapid urbanisation, many urban cities in the country are facing ever more severe traffic congestion problems due to dense populations and the increasing number of cars on the - 14 - China Railway Sector 9 January 2015

Railway orders from overseas driven by diplomatic ties with China Both constructors’ and equipment makers’ overseas revenue increased strongly in 1H14, and we expect this trend to continue going forward. We attribute this Robust revenue growth robust overseas growth to the China railway companies’ improved services and product overseas, but may come competitiveness, in terms of both pricing and quality. Given the improving economic outlook for other at a price countries and their intention to strengthen diplomatic ties with China, we expect to see more overseas orders for the railway constructors and equipment makers in We expect railway constructors’ and the next few years. equipment makers’ overseas revenue China has absorbed the HSR train technology gleaned contributions to rise. However, operating from its previous partnerships with Siemens risks could arise as a result of overseas (Germany), Bombardier (Canada), Kawasaki (Japan) expansion, especially for the railway and Alstom (France), and developed its own models on top of the prototypes provided by its foreign strategic constructors. partners. For example, China has now developed its own CRH380 long-version MUs, intercity low-speed MUs, MUs for cold weather and anti-sand MUs. As China aggressively promoting such, the country should not need help from foreign HSR products to the world companies going forward as it further develops its HSR rail network. As has been widely reported in the press, Premier Li Keqiang has taken the opportunity to promote China’s HSR products during his recent visits to Southeast Asia, Europe and Africa. We believe that both the China railway constructors and equipment makers are well prepared to benefit from the country’s “go abroad” policy, given their competitive advantages in providing quality products at a competitive cost compared with their international peers.

 Overseas business exposure comparison CRG CRCC CCCC 0390.HK 1186.HK 1800.HK (CNYm unless otherwise indicated) 2012 2013 2014E 2015E 1H14 2012 2013 2014E 2015E 1H14 2012 2013 2014E 2015E 1H14 Overseas backlog 104,082 137,220 254,223 356,236 138,048 235,911 294,652 445,184 584,275 323,135 131,783 172,414 260,069 400,525 188,987 Overseas backlog/Total backlog ratio 8% 8% 12% 14% 8% 16% 17% 21% 24% 18% 19% 23% 27% 32% 25% Overseas backlog coverage (x) 4.7 6.1 8.1 7.9 4.4 13.5 13.9 15.4 12.0 11.2 3.4 3.0 4.3 5.3 3.2 Overseas revenue 22,162 22,430 31,529 45,275 11,804 17,428 21,264 28,897 48,527 11,481 38,950 56,619 59,788 75,205 26,928 YoY growth 24% 1% 41% 44% 11% 1% 22% 36% 68% 7% 21% 45% 6% 26% 5% Overseas revenue/Total revenue ratio 5% 4% 5% 7% 4% 4% 4% 5% 7% 4% 13% 17% 17% 19% 17%

CSR CNR Zhuzhou CSR Times 1766.HK 6199.HK 3898.HK (CNYm unless otherwise indicated) 2012 2013 2014E 2015E 1H14 2012 2013 2014E 2015E 1H14 2012 2013 2014E 2015E 1H14 Overseas backlog 15,000 22,103 n.a. n.a. n.a. 11,300 12,800 n.a. n.a. 19,800 n.a. n.a. n.a. n.a. n.a. Overseas backlog/Total backlog ratio 19% 20% n.a. n.a. n.a. 17% 16% n.a. n.a. 18% n.a. n.a. n.a. n.a. n.a. Overseas backlog coverage (x) 1.8 3.5 n.a. n.a. n.a. 1.2 1.7 n.a. n.a. 1.8 n.a. n.a. n.a. n.a. n.a. Overseas revenue 8,479 6,397 18,305 22,803 4,568 9,659 7,600 n.a. n.a. 2,325 338 276 1,521 1,698 133 YoY growth 39% -25% 186% 25% 13% 54% -21% n.a. n.a. -40% 5% -18% 451% 12% 104% Overseas revenue/Total revenue ratio 10% 7% 15% 17% 9% 10% 8% n.a. n.a. 6% 5% 3% 12% 12% 3% Source: companies, Daiwa forecasts

- 15 - China Railway Sector 9 January 2015

 CSR and CNR: overseas new contracts awarded in 2014 Country from where order CSR Subsidiary Counterparty Product CNYbn derived 18/3/2014 Zhuzhou CSR Times Electric Co., Ltd Transnet Freight Rail Locomotives 12.80 South Africa 5/6/2014 CSR Yangtze PN Australia Freight wagons 0.13 Australia 5/6/2014 Nanjing Puzhen Rolling Stock, Sifang, Chengdu Singapore transportation bureau Rapid transit vehicles 1.20 Singapore 24/6/2014 CSR Zhuzhou Electric locomotive Macedonia transport bureau MUs 0.19 Macedonia 29/7/2014 CSR Qingdao Sifang Locomotive Argentina Transport Bureau Overhaul of MUs 0.52 Argentina 22/10/2014 CSR Zhuzhou Electric locomotive Syarikat Prasarana Negara Berhad Rapid transit vehicles 1.13 Malaysia 22/10/2014 CSR Zhuzhou Electric locomotive City&Industrial Devlp of Maharashtra Rapid transit vehicles 0.31 India CSR overseas contract in 2014 16.28

CNR Subsidiary Counterparty Products CNYbn Country 6/1/2014 Changchun ERC-Ethiopia Railway passenger carriages 0.11 Ethiopia 6/1/2014 Changchun SBASE-Argentina rapid transit vehicles 0.97 Argentina 6/1/2014 CNR Export & Import Co Argentina Transport MUs 0.50 Argentina 6/1/2014 Erqi Congo transport bureau locomotives 0.19 Congo 17/3/2014 Changchun HK MTR Shatin-Central Line rapid transit vehicles 0.90 Hong Kong 17/3/2014 Changchun Ethiopia transport bureau rapid transit vehicles 0.53 Ethiopia 17/3/2014 Qiqihaer BHP Billiton freight wagons 0.61 Australia 17/3/2014 Qiqihaer Rio-tino Hamersley Railway freight wagons 0.35 Australia 24/3/2014 Friedshelf 1507 Prop - CNR Transnet SOC locomotives 5.71 South Africa 10/6/2014 Dalian Philippine Transport Bureau rapid transit vehicles 0.54 Philippines 10/6/2014 Qiqihaer Vale-Mozambique freight wagons 0.98 Mozambique 10/6/2014 Qiqihaer BHP Billiton freight wagons 0.27 Australia 10/6/2014 Qiqihaer Pilbara freight wagons 0.06 Australia 14/7/2014 Erqi Congo Railway locomotives 0.11 Congo 10/9/2014 CNR Export & Import Co Argentina transport bureau MUs 0.74 Argentina 10/9/2014 Consorcio CNR &SPI Mozambican Rail and Ports passenger carriages 0.23 Mozambique 10/9/2014 Changchun Brazil-Rio transport bureau MUs 0.33 Brazil 10/9/2014 Qiqihaer BHP Billiton freight wagons 0.21 Australia 22/10/2014 Changchun Massachusetts Dept of Transport rapid transit vehicles 3.49 US CNR overseas contract in 2014 16.81 Source: Companies

 HSR construction costs comparison Competitive edge of China’s HSR Length Total cost Unit cost From To (km) (CNYbn) (CNYm/km) Completion Date constructors over overseas peers China Shijiazhuang Zhengzhou 355 43.9 123 2012 China now leads the world in terms of the length of its Guiyang Guangzhou 857 94.6 110 2014 Jilin Hunchun 360 39.6 110 2014 HSR. By the end of 2014, we estimate that China Nanning Guangzhou 463 41.0 89 2014 Railways had built a network covering 19,000km, and Harbin Jiamusi 343 33.9 99 2017E this was built rapidly at a relatively low cost compared Zhanjiakou Hohhot 286 34.6 121 2017E with similar projects in the other countries. Spain Cordoba Malaga 155 30.6 197.1 2007 Madrid Barcelona 749 158.6 211.7 2008 Cost of HSR lines Madrid Valladolid 177 50.4 284.7 2007 The main factors impacting the cost of HSR lines France include the line’s design speed, the type of track, the Paris Moselle 300 67.9 226.3 2007 Source: CRC, Texas A&M Transportation Institute, Daiwa topography (building in mountainous areas is more expensive as it requires extensive tunnelling and bridge As seen from the previous table, it is apparent that the work), weather conditions (cold regions may require cost of HSR construction in China is considerably lower special design features for the track bed), and land than in Europe, or about two-thirds, on average, of the acquisition costs, etc. total cost in other countries. We attribute the lower costs in China to: 1) lower cost of labour, 2) lower cost According to cost data sourced from the official of land acquisitions and resettlement, and 3) greater publications of the CRC, HSR lines built to accommodate economies of scale, ie, the large scale of the HSR 350km/hour in China have an average infrastructure network planned for China allows for the cost of USD17-21m/per kilometre, with a high ratio of standardisation of design work and the amortisation of viaducts and tunnels. Meanwhile, the reports estimate capital costs for construction equipment over a number that the construction costs for HSR lines at 300km/hour of projects. or above in Europe are USD25-39m/km.

- 16 - China Railway Sector 9 January 2015

chance of the consortium successfully suing the Mexico Overseas: big markets with good government under the country’s own jurisdiction, and growth potential, but at a price even if the consortium were to win the case, any compensation would likely be insignificant. Despite the China Government’s strong intention that the railway SOEs will expand their overseas businesses We see growing operational risks arising for the China and, thus, their competitive advantage over their railway constructors as they increase their overseas international peers, we still see a number of potential exposure. As such, we are concerned that there will be risks relating to such aggressive overseas expansion, times when the risk-reward ratios of the China railway especially for the China railway construction constructors bidding for overseas projects will not be companies. justifiable, exposing them to significant downside risk, even if overseas projects generally have higher margins Given China railway constructors’ insufficient than domestic railway construction projects. operating experience in several new markets overseas, and also the difference in business environment between China and overseas markets, we believe the “One belt one road” policy China railway constructors will face a few challenges in establishing overseas businesses going forward, China has announced that it is in the process of namely: 1) legal and regulatory requirements, 2) contributing USD40bn to a Silk Road fund to differences in licensing and tendering regimes, 3) encourage infrastructure, industrial, and financial payment and business practices, 4) potentially adverse cooperation relating to connectivity for several tax consequences, and 5) local competition and countries along the “One belt one road", referring to protectionism. China’s Silk Road Economic Belt and the 21st Century Maritime Silk Road initiatives. As we have already mentioned, the main advantages enjoyed by the China railway constructors are: 1) low We believe China’s aim when setting up the fund is to labour costs, 2) low land acquisition/resettlement costs export technology, reduce excess capacity, and deepen by constructing more viaducts, and 3) greater economic and political relationships with its economies of scale as a result of China’s concentrated neighbouring countries. construction (ie, FAI of CNY800bn) of its HSR network. In some overseas countries, the China railway Most of the areas involved in the “one belt one road” constructors may not have the same low cost plan are in western China, where the population advantages. Also, some overseas contracts may have density is smaller than it is in eastern China. We tight construction periods, while land acquisition and believe HSR construction for the Silk Road is still resettlement overseas can come with political risks. undergoing a preliminary feasibility study and is unlikely to materialise in the near term. An example of overseas operating and political risk causing issues involved Mexico’s decision in November  China: “One belt one road” map 2014 to abruptly cancel a USD3.75bn HSR deal with a consortium led by CRCC. The deal was scrapped after the Mexican government was accused by politicians of favouring the CRCC consortium. While Mexico has since acknowledged that the bid was legitimate, it said Moscow its decision to scrap the deal was aimed at avoiding any Xi Venice Urumqi doubts about the legitimacy and transparency of the Istanbul project. Xi’an

Fuzhou The project was reported widely in the press to have Kuala Lumpur included tough terms, ie, a tight bidding period and Nairobi short construction period, which led to a number of Silk Road Economic Belt international players, including Germany’s Siemens, Canada’s Bombardier and France’s Alstom not being Maritime Silk Road able to submit their bids on time. The Export-Import Source: Daiwa Bank of China was going to finance 85% of the project. CRCC has since said it would set up a legal team to protect its legitimate interests. However, we see little

- 17 - China Railway Sector 9 January 2015

China National Railway Locomotive & Rolling Stock Industry Corp in a bid to introduce competition into China’s railway equipment market.

Merger could speed up standardisation of CSR/CNR: merging to technology standards We believe the CRC will lead the research and avoid direct overseas development into new national standards for high- speed trains in order to reduce maintenance costs and competition boost exports. If the 2 railway equipment makers merge successfully, we believe this would speed up the standardisation process for railway technology, CSR and CNR announced their merger resulting in lower train maintenance and operating plan and resumed trading on 31 costs in the future.

December 2014. We would expect the Zhuzhou CSR should benefit the most from merged entity to enjoy stronger pricing substantial market-share gains power as a monopoly in the domestic We believe Zhuzhou CSR could benefit the most from market, and higher market share the merger between CSR and CNR. During our meeting overseas on reduced competition. with Zhuzhou CSR at Daiwa’s Investment Conference in Hong Kong in November 2014, management said it

does not produce any locomotives or MU components CSR and CNR pending merger for CNR because of the difference in technology CSR and CNR announced their merger plan and platforms between CSR and CNR, but that it has the resumed trading on 31 December 2014, after having ability to start producing components for CNR once it been suspended from trading since October. According makes some technological adjustments. Thus, we to the proposed plan, CSR and CNR will merge through estimate that earnings for Zhuzhou CSR could rise by a share swap, involving 1 CNR share for 1.1 CSR shares; about 35% from the current level, if it starts to provide the conversion ratio is the same for both A shares and components to CNR. H shares. CNR will be delisted upon completion of the merger. The merged entity will be renamed CRRC Moreover, Zhuzhou CSR should also benefit from the Corporation Limited (CRRC) in a bid to increase current high backlog of its parent company, CSR. With competitiveness in the overseas railway equipment concentrated delivery of locomotives and MUs for CSR, market. Zhuzhou CSR is expected to receive more orders for key components from parent CSR. The components Shareholders of A shares and H shares who object to Zhuzhou CSR provides to CSR on average account for the merger plan have the option of receiving HKD7.32 about 12% of the selling price of an MU, or 17% of that for each CSR H share and HKD7.21 for each CNR H for a locomotive. share, or CNY5.63 for each CSR A share and CNY5.92 for each CNR A share. CSR and CNR to benefit from higher margins and cost savings For the proposed merger plan to proceed, other than regulatory approvals from Hong Kong’s Securities and If the merger between CSR and CNR goes ahead, we Futures Commission (SFC), Hong Kong Exchanges and would expect the merged entity to have much more Clearing (HKEx) and the State Council of China, it also bargaining and pricing power for both HSR trains and requires more than 75% approval at a shareholders’ urban rail transit market, as the merged entity would meeting, and opposition from not more than 10% of the then be the only railway equipment maker in China. total number of H shareholders. It was reported that R&D costs would also be reduced as a result of the the State-owned Assets Supervision and merger. Administration Commission (SASAC) was behind facilitating the merger of CSR and CNR in order to In overseas markets, the merged entity would be able avoid direct competition in the competitive overseas to avoid direct competition from each other, and hence market. possibly lift overall overseas margins and gain market share. Currently, CSR and CNR’s combined share of CSR and CNR were established in 2000 and 2002 the overseas rolling stock market is less than 10%. respectively, through the allocation of assets from

- 18 - China Railway Sector 9 January 2015

Competitive advantage of the CSR vs. CNR: how do they differ China railway equipment players in terms of technology? over overseas peers CSR and CNR are China’s 2 state-owned companies CSR and CNR have emerged in the international that specialise in the manufacture of rolling stock in market as competitive rolling stock manufacturers in China. The China Government relies on CSR and CNR recent years. Even though they have yet to export to develop HSR technology. In a nutshell, China’s HSR complete MUs on a meaningful basis, CSR and CNR technology roadmap is divided into 3 stages: are already major providers of locomotives and wagons 1. Form partnerships with foreign makers of HSR in several overseas markets. trains through joint ventures and technology licensing. With many countries overseas having constrained 2. Assimilate the technology. budgets for capital-intensive HSR projects, we think the China railway equipment makers have a 3. Develop its own patented technology. competitive advantage in the international markets with their low cost for manufacturing rolling stock. CSR versus CNR: comparison

In the next table, which shows comparable technical The 2 companies are of similar scale in terms of sales specifications, we can see that Chinese rolling stock value and product mix. companies’ contract prices are at least about 30% lower than those of the international players.  CSR versus CNR CNYbn CSR CNR Company  Bombardier vs. CSR: contract prices for major products

Bombardier CSR CSR vs. BBDB Electric locomotives Order backlog (2013) 111 82 Item E464 HXD1C Backlog-to-sales ratio 1.1 0.8 Particulars 3500kW GTO 7200kW IGBT 2x power % of sales from MOR (2013) 41% 49% Sold to Italy China Major shareholders CSR Group CNR Group Quantity 50 590 Technology partners Total contract value (loc curr m) 186 8,600 High-speed trains Bombardier, Kawasaki, Siemens, Alstom Unit price original (loc curr) 3.7 14.6 Hitachi, Mitsubishi Unit price (CNYm) 23.4 14.6 38% discount High-power locomotives Siemens Alstom, Toshiba Source: Companies Metro carriages Item MOVIA Type A To enter the China market, foreign rolling-stock Particulars IGBT AC 80km/h IGBT AC 80km/h Similar manufacturers have to form partnerships with the Sold to India China Quantity 76 N/A state-owned rolling-stock makers. Through these joint Total contract value (loc curr m) 120 N/A ventures, China developed its first-generation high- Unit price original (loc curr) 1.6 7 speed train (speeds of up to 250-300km/hour), and Unit price (CNYm) 9.9 7 29% discount then its second-generation high-speed train (speeds of

High-speed MUs up to 380km/hour). Item REGINA CRH1A Particulars Prototype of CRH1 250km/h Similar CSR and CNR have both formed joint ventures with Sold to Sweden China different technology partners in the past: Quantity 18 320 Total contract value (loc curr m) 101 5200 - CSR has in the past partnered with Bombardier Unit price original (loc curr) 5.6 16.3 to develop the CRH1 model, based on Unit Price CNYm 35.4 16.3 54% discount Bombardier’s Regina models, and with the

Diesel locomotives Japanese train makers (Kawasaki, Hitachi and Item TRAXX HXN5 Mitsubishi) to develop the CRH2 train, based on Particulars 3000 hp 6000 hp 2x power the Kawasaki E2 series. Sold to Germany China Quantity 200 50 - CNR has in the past partnered with Siemens to Total contract value (loc curr m) 867 880 develop the CRH3 and Alstom to develop the Unit price original (loc curr) 4.3 17.6 CRH5 series. Unit price CNYm 27.3 17.6 35% discount

Source: Companies, Daiwa

- 19 - China Railway Sector 9 January 2015

We initiate coverage of Zhuzhou CSR with a Buy (1) call and 12-month target price of HKD58, based on a 2016E PER of 18.5x, which is in line with the stock’s past-5- year average PER. Our target price is equivalent to a 2015E PER of 21.1x, on our forecasts. However, our earnings forecasts do not incorporate the potentially Key stock calls positive impact of a merger of CSR and CNR. We believe the merger could result in about 30% upside to We prefer railway equipment makers our base-case earnings forecast for 2016E; relative to this higher theoretical post-merger earnings base for over railway constructors, as we see 2016E, our target price of HKD58 is equivalent a PER greater visibility on demand for rolling of 14.3x. stock going forward. Zhuzhou CSR is our Currently trading at PERs of 18.1x for 2014E and 16.3x top pick, followed by CSR. for 2015E, Zhuzhou CSR offers ROEs of 23.3% and 21.6% and dividend yields of 1.4% and 1.6% for 2014E Buy rolling-stock manufacturers and 2015E, respectively, which we consider attractive amid China’s railway FAI upcycle.

Prefer railway equipment makers The main risks to our call on Zhuzhou CSR include: 1) a We prefer railway equipment makers over railway slower-than-expected product delivery schedule; 2) constructors, as we believe demand for rolling stock unexpected changes in regulatory policy; and 3) will offer the most visibility going forward. slower-than-expected margin expansion.

Top pick: Zhuzhou CSR (3898 HK, HKD44.65,  Zhuzhou CSR: PER band Buy [1]) (HKD) 30x 25x 20x Zhuzhou CSR mainly provides train power converters 45 Historical Avg PER: 16.9x 15x and auxiliary power supply and control systems for the 40 locomotives, electrified MUs and RTVs produced by its 35 parent company, CSR. Railway-related products 30 10x accounted for 93% of Zhuzhou CSR’s total revenue in 25 1H14, and we view the company as a direct beneficiary 20 15 5x of increased railway equipment FAI. 10 5 In our view, Zhuzhou CSR benefits from parent CSR’s 0 concentrated delivery of MUs. According to the Jun-07 Jun-08 Jun-09 Jun-10 Jun-11 Jun-12 Jun-13 Jun-14 Dec-06 Dec-07 Dec-08 Dec-09 Dec-10 Dec-11 Dec-12 Dec-13 Dec-14 delivery schedule of CSR, we estimate Zhuzhou CSR would have had to deliver some 230 MUs in 2014. Source: Company, Daiwa Moreover, we believe Zhuzhou CSR would benefit the most from a potential merger of CSR and CNR, as it would be able to provide train components to CNR, which could significantly increase its market share.

We think Zhuzhou CSR would also benefit from its parent company’s potential market-share gains overseas if the merger between CSR and CNR goes ahead. Zhuzhou CSR’s IGBT business, which designs and produces semiconductor components used as electronic switches for rolling stock, is performing well, and it expects this business to make an earnings contribution in 2017, according to management.

We believe Zhuzhou CSR’s advanced technology in railway components is a major factor that differentiates parent CSR from CNR, as evidenced by the former’s historical valuation premium over the latter.

- 20 - China Railway Sector 9 January 2015

We like CSR for its high backlog coverage  CSR: PER bands and market-share gains overseas (HKD) Historical Avg PER: 17x 30x 25x 20x We like CSR due to its high backlog coverage, which 12 stood at 1.2x as at the end of 1H14. On our estimates, 10 CSR’s MU backlog should support its business growth 15x into 2015. Moreover, we believe China’s investment in 8 train purchases will continue to grow over 2015-16, as 6 10x the government is keen to stabilise the growth of 4 railway infrastructure investment relative to other 5x 2 infrastructure projects, while passenger growth is buoyant and load factors on the present HSR are rising. 0

Feb-09 Feb-10 Feb-11 Feb-12 Feb-13 Feb-14 Aug-08 Nov-08 Aug-09 Nov-09 Aug-10 Nov-10 Aug-11 Nov-11 Aug-12 Nov-12 Aug-13 Nov-13 Aug-14 Nov-14 May-09 May-10 May-11 May-12 May-13 May-14 Our positive view on CSR also reflects the stable and Source: Daiwa visible outlook for railway equipment FAI for 2015-16, the company’s concentrated delivery of locomotives Our order of preference and MU products on which gross margins are relatively high (2014-16E), and robust RTV demand and overseas Our top picks within our coverage are Zhuzhou CSR growth (for 2014-16E). (3898 HK, HKD44.65, Buy [1]) and CSR (1766HK, HKD10.28, Buy [1]). We believe both CSR and Zhuzhou CSR would benefit from cost savings and reduced competition in We also like CRG (390 HK, HKD6.17, Buy [1]) for its international markets in the event of a merger of CSR exposure to the urban rail transit market, and CRCC and CNR. Should the merger go ahead, we would (1186 HK, HKD9.73, Buy [1]) for its exposure to, and expect the combined entity to have greater bargaining experience in, international markets. and pricing power for HSR trains and RTV for urban rail transit systems, as the merged company would However, we rate CCCC (1800 HK, HKD9.66) as a effectively have a monopoly position as the only railway Hold (3), given its relatively modest exposure to equipment maker in China. Its R&D expenditure would railway construction. Local governments’ high debts also decline, in our view. and weak land sales could weigh on planned investments in road and port projects. We initiate coverage of CSR with a Buy (1) call and 12- month target price of HKD13.3, which is set at a 2016E Our order of preference: Zhuzhou CSR, CSR, CRG, PER of 15x applied to our pro-forma EPS, similar to the CRCC and CCCC. stock’s past-5-year average.

Currently trading at PERs of 19.5x for 2014E and 17.0x for 2015E, CSR offers ROEs of 15.0% and 15.3% for 2014E and 2015E, respectively, on our forecasts. As we see it, the market has yet to fully factor in CSR’s possible market-share gains in international markets and stronger pricing power in the domestic and export markets. We would expect the stock to be rerated in the event of a merger with CNR.

- 21 - China Railway Sector 9 January 2015

Risk to our calls Product quality issues Concerns over product quality within the sector increased following the HSR accident in Wenzhou in Anti-trust risk 2011. In the aftermath of the accident railway We believe a merger of CSR and CNR could have anti- construction activity slowed and the authorities trust law implications in some developed countries, reduced the speed of the HSR to 300 km/h from 350 though both companies are currently more exposed to km/h. Although we believe the risk of another high- developing countries, where such laws have not been profile has declined, given the major lines have been implemented. Anti-trust risks should not be significant running for 5 years, we believe any major incident in China, given the planned deal is being driven by would likely trigger a far-reaching investigation that SASAC and the government itself. could result in delays in railway investment on a 1- to 2-year horizon. Policy risk: overseas Penetrating new international markets can increase Rising raw material costs operating risks if the company concerned lacks the Construction contracts in the sector are mostly priced requisite experience. Differences in the business using a cost-plus mechanism, in which the construction environment, including legal and regulatory companies can ask for compensation in the event of a requirements, tendering regimes, and market-access significant rise in raw-material prices. However, the requirements and limitations, are potential challenges. compensation may be subject to negotiations and it could be 1 to 2 quarters before the payment is made. In Policy risk: China our view, swings in raw material prices tend to have Infrastructure construction in China is highly sensitive little long-term impact on companies, but rather have to government policy, such as the state government’s short-term effects on earnings and cash flow. five-year plans and the stimulus packages of 2009 and 2012. As we expect China’s GDP growth to continue to Currency risk on international projects slow (our economics team forecasts 6.9% GDP growth As overseas projects are typically denominated in US this year, down from 7.2% in 2014E), we believe dollars, any appreciation or depreciation of the railway investment is likely to be maintained at high Renminbi against the US dollar would impact the value levels. However, there are likely to be YoY adjustments, of cash flows from such projects. and the total investment amount will still depend on the government’s outlook for GDP growth in any given year. Hence, there is a risk that such investment may be adjusted down if economic growth exceeds the government’s expectations.

Risk on payment delay or default CRC’s sources of financing are much more diverse than they were 5 years ago, and we see little risk of delays in payments from CRC going forward. However, we do see a risk of delays in payments by provincial governments for urban transit railway projects, especially those involving less affluent provinces in inland or western China. Separately, overseas projects may entail more uncertainty than domestic ones, as there could be payment delays or defaults by customers in some international markets where visibility is not high.

- 22 - China Railway Sector 9 January 2015

 Valuations: railway equipment Market 7-Jan-15 Stock Share cap PER (x) PBR (x) Dividend yield (%) EV/EBITDA (x) ROE (%) Company code Currency Price Rating (USDm) FY14E FY15E FY16E FY14E FY15E FY2016 FY14E FY15E FY16E FY14E FY15E FY16E FY14E FY15E FY16E CSR * 1766 HK HKD 10.3 Buy 18,300 19.5 17.0 14.9 2.8 2.5 2.2 1.5 1.8 2.0 12.8 11.4 10.2 15.0 15.3 15.6 CNR 6199 HK HKD 11.0 NR 18,426 18.2 15.9 14.3 2.2 2.0 1.8 1.5 1.9 1.9 14.5 12.8 11.6 13.2 12.9 13.1 Zhuzhou CSR Times * 3898 HK HKD 44.7 Buy 6,768 18.1 16.3 14.3 3.8 3.3 2.8 1.4 1.6 1.8 14.4 12.5 10.7 23.3 21.6 20.9 China Railway Equipment - H Shares 18.6 16.4 14.5 2.9 2.6 2.2 1.5 1.7 1.9 13.9 12.3 10.8 17.2 16.6 16.5

CSR 601766 CH CNY 8.5 NR 18,781 20.7 17.9 15.7 2.9 2.6 2.3 1.5 1.6 1.8 15.8 13.8 12.5 13.8 14.3 14.4 CNR 601299 CH CNY 9.5 NR 18,431 19.6 16.6 14.0 2.3 2.1 1.9 1.6 2.0 2.0 14.6 12.8 11.5 13.0 13.5 14.0 China ITS 1900 HK HKD 1.0 NR 213 20.0 8.9 7.6 0.5 0.4 0.4 0.6 0.6 1.2 13.7 7.0 5.3 2.2 4.9 5.4 China Automation G 569 HK HKD 1.2 NR 163 7.9 6.9 6.2 0.5 0.5 0.5 1.6 4.1 4.7 6.2 5.8 5.4 5.5 6.2 6.7 Midas Hldgs 1021 HK HKD 1.9 NR 301 32.7 20.8 12.5 0.6 0.6 0.6 2.7 2.9 3.6 13.9 9.8 8.2 1.2 3.0 5.0 Ugl Limited UGL AU AUD 2.1 NR 287 14.0 5.9 5.4 0.4 0.4 0.4 5.7 9.5 10.3 9.9 7.3 6.9 2.7 7.7 8.3 Downer Edi Ltd DOW AU AUD 4.5 NR 1,567 9.5 9.4 9.2 1.0 0.9 0.9 5.4 5.8 5.9 3.7 3.6 3.6 10.2 9.9 9.7 Automation & Railway Equipment - AeJ 17.8 12.3 10.1 1.2 1.1 1.0 1.2 1.4 1.7 11.1 8.6 7.6 6.9 8.5 9.1

General Electric Co GE US USD 24.1 NR 241,816 14.6 13.7 13.1 1.9 1.8 1.6 3.7 3.9 4.1 9.2 8.7 8.7 11.9 13.0 12.1 Honeywell Intl Inc EMR US USD 60.3 NR 41,736 15.2 14.1 13.4 4.0 3.8 3.2 3.1 3.4 3.6 9.0 8.6 8.6 26.7 27.3 24.6 Emerson Elec Co HON US USD 98.8 NR 77,342 17.8 16.2 14.6 3.9 3.5 3.1 1.9 2.1 2.3 10.7 9.8 8.9 23.7 23.2 23.2 Hollysys Automation Technolo HOLI US USD 24.4 NR 1,403 15.0 13.2 11.7 2.4 2.0 1.7 0.9 1.1 1.2 10.8 9.5 8.4 17.6 17.1 16.5 Siemens Ag SIE GR EUR 92.2 NR 96,083 13.0 12.2 11.1 2.4 2.2 1.9 3.7 4.0 4.5 9.1 8.5 8.0 19.1 18.0 18.7 Abb Ltd ABBN VX CHF 20.3 NR 46,213 16.3 14.1 12.4 2.4 2.4 2.2 3.8 4.0 4.2 8.7 8.0 7.3 14.3 16.1 17.5 Schneider Electric SU FP EUR 57.8 NR 39,955 15.3 13.6 12.3 1.8 1.7 1.6 3.3 3.6 4.0 10.8 9.9 9.2 12.0 12.7 13.3 Alstom ALO FP EUR 26.5 NR 9,718 17.2 14.9 13.4 1.5 1.3 1.2 1.6 1.8 1.8 12.6 12.0 13.2 10.0 10.9 10.9 Bombardier Inc BBD/B CN CAD 4.0 NR 5,928 8.1 7.8 8.9 2.5 2.0 1.7 2.9 2.8 2.7 8.4 7.4 7.1 33.3 32.2 22.7 Rockwell Automation Inc ROK US USD 106.3 NR 14,413 15.8 14.4 13.0 5.0 4.4 3.6 2.4 2.6 2.7 9.8 9.1 8.5 32.6 32.7 33.1 Ansaldo Sts STS IM EUR 8.2 NR 1,942 20.1 19.1 17.7 3.0 2.7 2.5 1.8 1.9 2.0 10.7 10.1 9.4 15.1 14.4 14.3 Automation & Railway Equipment - Europe & US 15.3 13.9 12.9 2.8 2.5 2.2 2.6 2.8 3.0 10.0 9.2 8.8 19.7 19.8 18.8

Hitachi 6501 JP JPY 872.7 Outperform 35,301 14.8 11.7 10.6 1.5 1.3 1.2 1.4 1.5 1.6 7.8 7.1 6.8 9.8 11.4 11.3 Toshiba Corp 6502 JP JPY 494.6 Neutral 17,541 14.8 11.2 9.9 1.5 1.4 1.2 1.7 1.9 2.1 7.1 6.1 5.8 10.4 12.8 13.3 Mitsubishi Hvy Ind 7011 JP JPY 655.9 Neutral 18,519 18.5 14.2 12.4 1.3 1.3 1.2 1.5 1.8 2.0 7.7 7.0 6.5 7.4 8.8 9.8 Kawasaki Heavy Ind 7012 JP JPY 539.0 Outperform 7,542 17.8 14.2 12.8 2.2 2.0 1.8 1.5 1.8 2.1 10.6 8.6 8.0 13.2 15.5 15.1 Nabtesco Corp 6268 JP JPY 2837.0 Neutral 3,045 20.6 19.2 17.0 2.5 2.3 2.2 1.4 1.5 1.7 11.5 10.5 9.8 12.7 12.7 13.6 Toyo Electric Mfg 6505 JP JPY 391.0 NR 159 15.7 12.6 10.5 0.9 0.9 0.8 1.5 1.5 1.5 7.8 6.6 5.6 6.0 7.0 8.1 Nippon Signal Co 6741 JP JPY 1219.0 NR 697 16.3 14.8 13.9 1.2 1.1 1.1 1.5 1.6 1.7 7.4 6.8 6.6 7.3 7.6 7.5 Kinki Sharyo Co 7122 JP JPY 323.0 NR 187 n.a. n.a. n.a. n.a. n.a. n.a. n.a n.a n.a n.a. n.a. n.a. n.a. n.a. n.a. Yokogawa Electric 6841 JP JPY 1273.0 NR 2,862 32.1 14.2 13.1 1.7 1.5 1.4 0.9 1.4 1.7 8.6 7.0 6.7 5.7 11.3 11.3 Automation & Railway Equipment - Japan Mean 18.8 14.0 12.5 1.6 1.5 1.4 1.4 1.7 1.8 8.6 7.5 7.0 9.1 10.9 11.2 Total Weighted average 15.7 14.0 12.9 2.4 2.2 2.0 2.9 3.1 3.4 9.9 9.1 8.7 15.6 16.2 15.9 High 32.7 20.8 17.7 5.0 4.4 3.6 5.7 9.5 10.3 15.8 13.8 13.2 33.3 32.7 33.1 Low 7.9 5.9 5.4 0.4 0.4 0.4 0.6 0.6 1.2 3.7 3.6 3.6 1.2 3.0 5.0 Median 16.3 14.2 12.8 2.2 2.0 1.7 1.6 1.9 2.0 9.9 8.6 8.2 12.7 12.9 13.3 Source: Bloomberg, *Daiwa forecasts - 23 - China Railway Sector 9 January 2015

 Valuations: railway construction Market 7-Jan-15 Stock Share Target cap PER (x) PBR (x) Dividend yield (%) EV/EBITDA (x) ROE (%) Company code Currency Price Rating Price (USDm) FY14E FY15E FY16E FY14E FY15E FY2016 FY14E FY15E FY16E FY14E FY15E FY16E FY14E FY15E FY16E CRG * 390 HK HKD 6.2 Buy 7.5 28,468 9.5 8.5 7.8 1.1 1.0 0.9 1.6 1.8 1.9 9.1 8.8 8.4 12.1 12.1 12.0 CRCC * 1186 HK HKD 9.7 Buy 11.7 28,174 8.3 8.7 7.9 1.1 1.0 0.9 1.9 1.8 2.0 5.8 5.7 5.5 13.4 12.2 11.6 CCC * 1800 HK HKD 9.7 Hold 9.3 32,140 9.7 8.8 8.3 1.2 1.1 1.0 2.7 2.7 2.9 8.4 8.2 8.2 12.9 12.7 12.3 CSCI * 3311 HK HKD 11.3 Buy 16.9 5,836 12.5 9.6 7.6 2.2 1.9 1.6 2.4 3.1 3.9 10.8 8.5 6.9 19.6 21.4 22.6 MCC 1618 HK HKD 2.7 NR NR 13,920 10.4 7.3 6.2 0.8 0.8 n.a. 1.9 2.8 3.2 15.8 13.3 16.4 9.0 11.0 n.a. Sinopec Engineering 2386 HK HKD 5.9 NR NR 3,357 5.4 5.0 4.7 0.9 0.8 0.7 6.0 6.4 6.8 1.9 1.8 1.7 17.8 17.1 16.1 CMEC 1829 HK HKD 6.5 NR NR 3,431 10.0 8.4 7.6 1.6 1.4 1.3 3.8 4.4 5.0 1.9 1.6 1.4 17.1 17.7 18.0 China Construction Companies - H Shares Average 9.4 8.1 7.2 1.3 1.1 1.1 2.9 3.3 3.7 7.7 6.8 6.9 14.6 14.9 15.4

CRG 601390 CH CNY 9.1 NR NR 28,468 18.6 16.7 15.7 2.0 1.9 1.7 0.8 0.9 0.9 11.7 10.7 10.0 11.3 11.3 11.1 CRCC 601186 CH CNY 15.5 NR NR 28,174 17.1 15.6 14.8 2.1 1.9 1.7 0.9 1.0 1.0 8.4 7.6 7.1 12.9 12.5 12.1 CCC 601800 CH CNY 14.1 NR NR 32,140 16.6 15.2 13.4 2.2 1.9 1.7 1.5 3.0 1.9 11.5 10.5 9.3 13.4 12.9 13.2 MCC 601618 CH CNY 5.0 NR NR 13,920 23.6 16.5 15.5 2.0 1.8 n.a. 0.8 1.2 n.a 12.3 10.8 n.a. 8.0 11.0 n.a. China Construction Engineering 601668 CH CNY 7.1 NR NR 34,287 8.8 7.7 6.7 1.5 1.3 1.2 2.4 2.6 2.8 8.9 7.8 6.7 17.9 17.6 17.4 China Railway ErJu 600528 CH CNY 15.4 NR NR 3,613 n.a. n.a. n.a. n.a. n.a. n.a. n.a n.a n.a n.a. n.a. n.a. n.a. n.a. n.a. Long Yuan Cons 600491 CH CNY 6.9 NR NR 1,054 30.7 22.7 17.3 n.a. n.a. n.a. n.a n.a n.a n.a. n.a. n.a. n.a. n.a. n.a. Shanghai Tunnel Engineering 600820 CH CNY 8.7 NR NR 4,378 15.4 13.0 14.7 n.a. n.a. n.a. n.a n.a n.a n.a. n.a. n.a. 10.8 11.3 11.6 Shanghai Construction 600170 CH CNY 8.5 NR NR 6,248 20.0 18.3 21.2 n.a. n.a. n.a. n.a n.a n.a n.a. n.a. n.a. n.a. n.a. n.a. China CAMC Engineering 002051 CH CNY 29.2 NR NR 3,638 25.8 21.0 18.0 4.1 3.5 3.0 1.0 1.3 1.5 10.7 8.9 8.4 16.1 17.1 16.9 Hongrun Construction 002062 CH CNY 6.1 NR NR 768 n.a. n.a. n.a. n.a. n.a. n.a. n.a n.a n.a n.a. n.a. n.a. n.a. n.a. n.a. China Construction Companies - A shares Average 19.6 16.3 15.2 2.3 2.1 1.9 1.2 1.7 1.6 10.6 9.4 8.3 12.9 13.4 13.7

Danieli DAN IM EUR 20.2 NR NR 1,624 9.8 9.3 8.6 1.0 0.9 0.8 1.6 1.6 1.7 0.4 0.4 0.3 9.0 9.2 9.4 Voestalpine AG VOE AV EUR 31.3 NR NR 6,386 10.3 9.2 8.1 1.1 1.0 0.9 3.3 3.6 4.0 5.7 5.4 5.0 10.6 11.2 11.5 International Metallurgical Companies Average 10.0 9.3 8.3 1.0 1.0 0.9 2.4 2.6 2.8 3.0 2.9 2.7 9.8 10.2 10.5

Daewoo E&C * 047040 KS KRW 5160.0 Outperform 7,700 1,945 12.0 7.3 6.0 0.8 0.7 0.6 0.0 0.0 0.0 9.3 7.8 5.9 6.6 9.9 10.8 GS E&C * 006360 KS KRW 19900.0 Hold 27,000 1,281 n.a. 5.1 5.1 0.4 0.4 0.3 0.0 0.0 0.0 48.1 14.5 10.2 n.a 7.8 7.2 Hyundai E&C * 000720 KS KRW 39050.0 Outperform 70,000 3,944 6.9 6.0 5.4 0.8 0.7 0.6 1.3 1.3 1.3 4.0 3.5 2.6 12.4 12.8 12.2 Daelim Ind * 000210 KS KRW 58200.0 Outperform 85,000 1,837 10.6 5.7 4.8 0.5 0.4 0.4 0.3 0.3 0.3 8.6 4.4 3.2 4.5 7.9 8.8 Samsung Eng * 028050 KS KRW 33300.0 Underperform 66,500 1,208 10.2 7.0 4.8 1.3 1.1 0.9 0.0 0.0 0.0 11.8 6.9 4.6 13.5 16.7 20.2 ST Engineering STE SP SGD 3.4 NR NR 7,784 19.1 17.6 16.1 4.7 4.4 4.1 4.3 4.5 5.0 12.9 11.9 11.2 25.0 25.5 26.1 Shimizu 1803 JP JPY 795.0 Neutral 830 5,246 23.0 19.0 16.4 1.6 1.5 1.4 0.9 0.9 0.9 13.8 12.0 10.8 7.0 7.9 8.4 Nishimatsu Construction 1820 JP JPY 471.0 NR NR 1,096 15.1 12.9 12.8 0.9 0.9 0.8 1.5 1.6 1.6 13.5 n.a. n.a. 6.2 7.8 5.3 Toda Corp. 1860 JP JPY 450.0 NR NR 1,215 12.5 14.1 13.5 0.9 0.9 0.8 1.1 1.1 1.1 14.3 13.3 12.5 7.8 6.7 6.8 Gamuda GAM MK MYR 5.0 NR NR 3,276 15.3 14.5 13.4 2.0 1.8 1.6 2.6 2.7 2.7 20.7 18.6 16.9 13.5 13.2 13.0 Kolon E & C 003070 KS KRW 6760.0 NR NR 101 n.a. n.a. n.a. n.a. n.a. n.a. n.a n.a n.a n.a. n.a. n.a. n.a. n.a. n.a. Kajma 1812 JT JPY 471.0 NR NR 4,168 29.1 18.4 15.6 1.3 1.2 1.1 1.1 1.1 1.1 15.0 11.1 10.1 4.6 6.8 7.6 WCT Engineering WCTHG MK MYR 1.5 NR NR 458 11.6 9.9 8.6 0.8 0.7 0.7 4.5 4.7 4.9 12.2 10.7 9.4 6.5 7.3 8.0 IJM IJM MK MYR 6.6 NR NR 2,748 15.7 13.2 11.9 1.3 1.3 1.2 2.2 2.5 2.6 11.2 9.7 9.2 8.3 9.4 9.8 Asian Construction Companies Average 15.1 11.6 10.3 1.3 1.2 1.1 1.5 1.6 1.7 15.0 10.4 8.9 9.7 10.7 11.1 Source: Source: Bloomberg, *Daiwa forecasts - 24 - China Railway Sector 9 January 2015

 Valuations: railway construction (Cont’d) Market 7-Jan-15 Stock Share Target cap PER (x) PBR (x) Dividend yield (%) EV/EBITDA (x) ROE (%) Company code Currency Price Rating Price (USDm) FY14E FY15E FY16E FY14E FY15E FY2016 FY14E FY15E FY16E FY14E FY15E FY16E FY14E FY15E FY16E Vinci DG FP EUR 45.0 NR NR 31,409 12.7 12.3 11.6 1.7 1.6 1.5 4.6 4.1 4.3 7.6 7.6 7.4 13.9 13.3 13.3 ACS ACS SM EUR 28.2 NR NR 10,483 12.4 11.8 10.6 2.4 2.2 2.0 4.1 4.2 4.3 6.2 5.9 5.7 19.9 19.1 18.6 FCC FCC SM EUR 11.0 NR NR 3,402 n.a. 25.1 17.9 9.1 7.6 6.3 0.0 0.0 0.0 11.7 10.6 9.7 n.a. 45.3 39.6 Boskalis Westminster BOKA NA EUR 40.2 NR NR 5,847 11.3 12.7 12.3 1.7 1.6 1.5 3.4 3.5 3.7 6.9 7.5 7.6 14.8 12.3 12.1 Hochtief HOT GR EUR 57.6 NR NR 4,722 17.6 13.8 11.4 1.6 1.5 1.4 3.0 3.5 4.2 4.2 4.0 3.9 10.4 12.3 13.9 Skanska SKAB SS SEK 167.8 NR NR 8,844 19.3 16.5 15.4 3.1 2.9 2.7 3.9 4.1 4.3 11.4 10.3 9.8 17.5 18.9 18.6 Atlas Copco AB ATCOA SS SEK 211.0 NR NR 31,672 20.1 17.6 16.1 5.6 4.8 4.2 2.8 3.0 3.2 13.6 12.1 11.3 29.1 28.8 27.3 Sandvik AB SAND SS SEK 73.0 NR NR 11,495 15.3 13.3 11.4 2.6 2.5 2.3 4.8 5.1 5.5 9.4 8.8 7.8 17.2 18.3 20.7 Chicago Bridge & Iron Co NV CBI US USD 38.9 NR NR 4,211 7.5 6.7 6.3 1.5 1.2 1.0 0.7 0.7 0.9 5.7 5.0 5.1 22.5 20.8 16.9 McDermott International Inc MDR US USD 2.9 NR NR 696 n.a. 52.3 13.4 0.5 0.5 0.5 0.0 0.0 0.0 22.0 5.9 4.4 n.a. 0.8 0.1 Fluor FLR US USD 57.9 NR NR 9,039 13.8 12.2 10.8 2.6 2.3 2.0 1.4 1.4 1.5 5.7 5.2 4.9 18.2 18.9 17.8 US & Europe Construction Companies Average 14.4 17.7 12.5 3.0 2.6 2.3 2.6 2.7 2.9 9.5 7.5 7.1 18.2 19.0 18.1 Total Weighted average 13.9 12.5 11.4 2.0 1.8 1.6 2.0 2.2 2.2 9.4 8.4 7.6 14.3 14.7 13.8 High 30.7 52.3 21.2 9.1 7.6 6.3 6.0 6.4 6.8 48.1 18.6 16.9 29.1 45.3 39.6 Low 5.4 5.0 4.7 0.4 0.4 0.3 0.0 0.0 0.0 0.4 0.4 0.3 4.5 0.8 0.1 Median 12.7 12.8 11.5 1.5 1.3 1.2 1.6 1.8 1.9 10.6 8.3 7.6 12.9 12.4 12.2 Source: Source: Bloomberg, *Daiwa forecasts

- 25 - China Railway Sector 9 January 2015

Rapid Transit Vehicles  A linear metro carriage

Appendix

Types of rolling stock

High-speed railway MUs  China: example of a 250 km/h MU

Source: CNR

 A non-linear metro carriage

Source: CNR

 China: example of a 350 km/h MU Source: CNR

 A light-rail train

Source: CNR

Source: CNR

 An intercity railcar

Source: CNR - 26 - China Railway Sector 9 January 2015

Locomotives Freight wagon  Example of a DC electric locomotive  Example of an AC diesel locomotive

Source: CNR Source: CNR

 Example of an AC electric locomotive Passenger coach  Example of an AC diesel locomotive

Source: CNR

Source: CNR  Example of DC diesel locomotive

Source: CNR

 Example of an AC diesel locomotive

Source: CNR - 27 - China Railway Sector 9 January 2015

 CSR: HSR technology map (Kawasaki-CRH2-CRH380A) First generation of high-speed trains Model Train  China: high-speed trains at 250-300km/hour Base model CRH1 CRH2 CRH3 CRH5 Kawasaki Manufacturer CSR CSR CNR CNR E2 series Technology partners Bombardier Kawasaki Siemens Alstom (Japan) Hitachi Mitsubishi

Base model Regina series E2 series German Alstom

Shinkansen Deutsche Pendolino

Bahn's ICE 3 Manufactured by BST CSR Sifang CNR Tanshang CNR  CNR Changchun Changchun CSR CRH 2 Location Qingdao Qingdao Tangshan Changchun Speed: up to 250km/hr Changchun Manufactured by CSR Sifang In service since February 2007 January 2007 April 2008 2007 In service since January 2007 First in use Guangzhou- Shanghai- Beijing-Tianjin Beijing-Harbin Fleet size: 171 (February 2011) Shenzhen Hangzhou Zhengzhou- First deployed: Shanghai-Nanjing Shanghai-Nanjing Xi'an

Remarks Involved in 23 Involved in 23 July Developed for July 2011 train 2011 train crash the 350km/hr crash (D3115) (D301) category  CRH380B CSR CRH380A Fleet size 96 171 80 93 Speed: up to 380km/hr (February 2011) (February 2011) (October2010) (February Manufactured by CSR Sifang 2011) In service since December 2009 Source: Compiled by Daiwa Fleet size: 112 (June 2012) First deployed: Wuhan-Guangzhou  CSR: CRH1 versus protomodel (Bombardier Regina series)

CSR (Bombardier Sifang Transport) CRH1 Bombardier Source: CSR, Daiwa (First deployed: Guangzhou-Shenzhen Regina series (2007) (Canada)  CNR: HSR technology map (Siemens-CRH3-CRH380B) Model Train

Base model Siemens Deutsche Bahn ICE3 (Germany)

Source: Companies

  CNR: CRH5 versus protomodel (Alstom Pendolino) CNR CRH 3 CNR Changchun Alstom Speed: up to 300km/hr CRH5 Pendolino Manufactured by CNR Tangshan/Changchun First deployed: Beijing-Harbin (2007) (France) In service since April 2008 Fleet size: 80 (October 2010) First deployed: Beijing-Tianjin



CNR CRH380B Source: Companies Speed: up to 380km/hr Manufactured by CNR Tangshan/Changchun In service since January 2011 Fleet size: 105 (October 2011) First deployed: Shanghai-Hangzhou

Source: CNR, Daiwa

- 28 -

Industrials / China 3898 HK Industrials / China 9 January 2015

Zhuzhou CSR Times Electric

Zhuzhou CSR Times Electric Target (HKD): 58.00 Upside: 29.9% 3898 HK 7 Jan price (HKD): 44.65

Initiation: a key beneficiary of CSR/CNR merger 1 Buy (initiation) 2 Outperform • Stands to benefit the most from merger of CSR and CNR by 3 Hold gaining market share without paying any price 4 Underperform • As a key rolling stock components provider for parent CSR, 5 Sell ZZCSR should benefit from CSR’s high backlog coverage • Initiating with Buy (1) rating and 12-month target price of HKD58, based on an 18.5x PER for 2016E; top sector pick

How do we justify our view?

CSR’s potential market share gains ■ Risks overseas after the CSR/CNR merger. Key risks to our view are: 1) a slower-than-expected product ZZCSR’s trial production of delivery schedule, 2) slower-than- insulated gate bipolar transistors expected profit margin Brian Lam (IGBTs) is progressing well, and improvements, and 3) unexpected (852) 2532 4341 longer-term ZZCSR estimates changes in regulatory policies and [email protected] revenue from IGBTs will reach political risks. CNY2bn per year. We expect mass Kelvin Lau production to start in 2017. (852) 2848 4467 [email protected] ■ Catalysts Share price performance

Potentially strong 2014 results (due (HKD) (%) 55 190 in March) and an increase we expect ■ Investment case 46 163 China to announce in 1Q15 to its ZZCSR is our top pick in our China 38 135 railway FAI target for 2015 are near- Railway universe and we initiate 29 108 term share price catalysts, in our 20 80 coverage with a Buy (1) rating. We Jan-14 Apr-14 Jul-14 Oct-14 Jan-15 believe ZZCSR stands to benefit the view. Further, details of China’s 13th most from the planned merger of CSR Five Year Plan (FYP), due to be Zzhou CSR (LHS) Relative to HSI (RHS) (1766 HK, HKD10.28, Buy [1]) and released in 3Q15, could augur well CNR (unrated). Having not provided for investor sentiment towards 12-month range 21.30-52.20 ZZCSR as a railway player. Market cap (USDbn) 6.77 CNR with train components in the 3m avg daily turnover (USDm) 11.47 past, ZZCSR should gain substantial ■ Valuation Shares outstanding (m) 1,175 market share in CNR post-merger by Major shareholder CSRG (52.6%) becoming a train components Our 12-month target price is HKD58, based on a 2016E PER of 18.5x, provider for CNR, in our view. Financial summary (CNY) +1SD above ZZCSR’s past-5-year Year to 31 Dec 14E 15E 16E Also, we see ZZCSR as a beneficiary trading average PER of 15x. Our Revenue (m) 12,679 14,151 16,778 model has yet to factor in the Operating profit (m) 2,539 2,833 3,243 of a likely rise in China’s railway Net profit (m) 2,322 2,577 2,939 equipment FAI target for 2015 via its potentially positive impact of the CSR/CNR merger, and we contend Core EPS (fully-diluted) 1.975 2.192 2.500 parent CSR’s concentrated delivery EPS change (%) 48.3 11.0 14.0 schedule of MUs and other that ZZSCR’s 2016E EPS could rise Daiwa vs Cons. EPS (%) 17.9 16.6 19.1 locomotive products. We forecast by about 30% vs. our current PER (x) 18.1 16.3 14.3 Dividend yield (%) 1.4 1.6 1.8 ZZCSR to deliver 253 units of MUs forecast upon a successful integration of CSR and CNR. Our DPS 0.511 0.567 0.647 in 2015 and 291 units in 2016 (+15% PBR (x) 3.8 3.3 2.8 target price implies a 2015E PER of YoY for both years). We believe EV/EBITDA (x) 14.4 12.5 10.7 ZZCSR will also prosper from parent 21.1x. ROE (%) 23.3 21.6 20.9 Source: FactSet, Daiwa forecasts

See important disclosures, including any required research certifications, beginning on page 80 China Railway Sector 9 January 2015

1 Buy (initiation) How do we justify our view? 2 Outperform

3 Hold  Growth outlook

4 Underperform  Valuation 5 Sell  Earnings revisions

 Growth outlook  ZZCSR: net profit and net profit growth (2010-16E) We forecast ZZCSR to report net profit growth of 58% (CNYm) YoY to CNY2,322m for 2014. Bearing in mind the high 3,500 70% earnings base for 2014E, we project solid net profit 3,000 60% growth of 11% YoY for 2015 and 14% YoY for 2016, 2,500 50% driven by strong order deliveries of high-margin MUs 2,000 40% and locomotive products. Market-share gains overseas 1,500 30% by parent CSR would benefit ZZCSR as well, in our view. 1,000 20% 500 10% 0 0% 2010 2011 2012 2013 2014E 2015E 2016E Net Profit (LHS) Growth (YoY, RHS) Source: Company, Daiwa forecasts

 Valuation  ZZCSR: forward PER (x) On our forecasts, the ZZSR stock is trading at PERs of (PER) 16.3x for 2015 and 14.3x for 2016, which are below its 24 past-5-year trading average PER of 15x. We believe the +1 SD market has yet to factor in ZZCSR’s earnings growth 19 potential from providing rolling stock components on Avg 14 the back of market share gains overseas that we expect -1 SD for its parent CSR. Also, we expect the stock’s valuation 9 rerating potential to be enhanced following the merger of CSR and CNR, as ZZCSR would then be able to secure 4 CNR as a new customer. Jul-09 Jul-10 Jul-11 Jul-12 Jul-13 Jul-14 Apr-09 Oct-09 Apr-10 Oct-10 Apr-11 Oct-11 Apr-12 Oct-12 Apr-13 Oct-13 Apr-14 Oct-14 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Trading PE Average +1 SD -1 SD Source: Company, Daiwa forecasts

 Earnings revisions  ZZCSR: revisions to consensus EPS forecasts Compared with the Bloomberg consensus, we are more (CNY) optimistic on ZZCSR’s operational performance. Thus, 1.95 our net profit forecasts of CNY2,322m for 2014, 1.85 CNY2,577m for 2015 and CNY2,939m for 2016 are 18%, 1.75 17% and 19%, respectively, above those of the 1.65 consensus. We expect to see increases to the consensus 1.55 forecasts when ZZCSR reports its 2014 results in March, 1.45 which we believe will be strong. 1.35 1.25 Jul-14 Apr-14 Oct-14 Jan-14 Jun-14 Feb-14 Mar-14 Nov-14 Aug-14 Sep-14 May-14 FY15E FY16E Source: Bloomberg

- 30 - China Railway Sector 9 January 2015

 Key assumptions (CNYm) Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016E Total railway FAI (CNY m) 701,321 842,652 590,609 633,967 665,745 800,000 830,000 860,000 Total railway FAI (YoY %) 68 20 (30) 7 5 20 4 4 Train purchase investment (CNY m) 78,076.0 106,650.0 104,949.0 90,000.0 103,800.0 143,000.0 170,000.0 170,000.0 Train purchase investment (YoY) 37.9 36.6 (1.6) (14.2) 15.3 37.8 18.9 0.0

 Profit and loss (CNYm) Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016E Locomotive products 1,024 2,351 2,214 1,584 2,906 3,808 3,651 3,651 EMU train products 711 1,472 2,538 2,229 2,315 4,630 5,093 5,883 Other Revenue 1,590 2,009 2,327 3,341 3,559 4,241 5,406 7,244 Total Revenue 3,326 5,831 7,079 7,154 8,781 12,679 14,151 16,778 Other income 62 (81) 43 110 82 76 85 101 COGS (2,118) (3,679) (4,599) (4,781) (5,695) (8,101) (9,043) (10,837) SG&A (578) (963) (1,030) (1,044) (1,343) (1,893) (2,087) (2,474) Other op.expenses (89) (138) (135) (147) (160) (222) (273) (324) Operating profit 602 970 1,358 1,293 1,664 2,539 2,833 3,243 Net-interest inc./(exp.) 8 (3) (27) 9 27 24 25 33 Assoc/forex/extraord./others 14 26 50 99 12 120 120 120 Pre-tax profit 624 992 1,381 1,401 1,704 2,683 2,978 3,396 Tax (90) (138) (194) (178) (237) (362) (402) (458) Min. int./pref. div./others (4) (2) (3) (1) 1 1 1 2 Net profit (reported) 531 852 1,184 1,221 1,467 2,322 2,577 2,939 Net profit (adjusted) 531 852 1,184 1,221 1,467 2,322 2,577 2,939 EPS (reported)(CNY) 0.490 0.786 1.092 1.126 1.332 1.975 2.192 2.500 EPS (adjusted)(CNY) 0.490 0.786 1.092 1.126 1.332 1.975 2.192 2.500 EPS (adjusted fully-diluted)(CNY) 0.490 0.786 1.092 1.126 1.332 1.975 2.192 2.500 DPS (CNY) 0.195 0.305 0.340 0.350 0.323 0.511 0.567 0.647 EBIT 602 970 1,358 1,293 1,664 2,539 2,833 3,243 EBITDA 691 1,108 1,493 1,439 1,825 2,761 3,106 3,567

 Cash flow (CNYm) Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016E Profit before tax 624 992 1,381 1,401 1,704 2,683 2,978 3,396 Depreciation and amortisation 89 138 135 147 160 222 273 324 Tax paid (96) (159) (194) (178) (237) (362) (402) (458) Change in working capital (170) (347) (297) (217) (683) (1,107) (442) (764) Other operational CF items 5 130 217 95 (217) (120) (120) (120) Cash flow from operations 452 754 1,242 1,247 726 1,315 2,287 2,378 Capex (468) (369) (352) (403) (298) (721) (721) (721) Net (acquisitions)/disposals 1 6 28 21 5 0 0 0 Other investing CF items 393 (115) (294) 398 (1,034) 0 0 0 Cash flow from investing (73) (479) (618) 16 (1,327) (721) (721) (721) Change in debt 95 (122) 194 (632) 29 0 0 0 Net share issues/(repurchases) 0 0 0 0 1,776 0 0 0 Dividends paid (168) (211) (358) (397) (382) (379) (601) (667) Other financing CF items 36 489 128 (72) (4) (0) (0) (0) Cash flow from financing (37) 156 (35) (1,101) 1,418 (380) (601) (667) Forex effect/others 0 0 0 0 0 0 0 0 Change in cash 342 431 588 161 817 214 965 990 Free cash flow (16) 385 889 843 428 594 1,566 1,656 Source: FactSet, Daiwa forecasts

- 31 - China Railway Sector 9 January 2015

 Balance sheet (CNYm) As at 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016E Cash & short-term investment 1,139 1,569 2,158 2,319 3,136 3,350 4,315 5,305 Inventory 889 1,590 1,669 1,110 1,428 2,025 2,261 2,709 Accounts receivable 1,433 1,693 2,171 3,628 4,907 6,973 7,783 9,228 Other current assets 239 318 541 147 1,341 1,410 1,437 1,483 Total current assets 3,700 5,171 6,538 7,203 10,813 13,759 15,795 18,725 Fixed assets 1,313 1,378 1,503 1,701 1,830 2,154 2,448 2,712 Goodwill & intangibles 250 208 298 317 308 483 638 772 Other non-current assets 138 255 315 429 448 568 688 808 Total assets 5,401 7,012 8,654 9,650 13,398 16,965 19,569 23,016 Short-term debt 284 697 1,088 714 960 1,353 1,506 1,799 Accounts payable 718 1,013 907 1,274 1,750 2,489 2,779 3,330 Other current liabilities 469 659 925 1,044 1,111 1,604 1,790 2,122 Total current liabilities 1,471 2,368 2,920 3,032 3,821 5,446 6,075 7,251 Long-term debt 3 2 57 28 52 52 52 52 Other non-current liabilities 48 139 240 277 376 376 376 376 Total liabilities 1,522 2,510 3,216 3,337 4,248 5,874 6,503 7,679 Share capital 3,569 4,075 5,317 6,178 9,016 9,016 9,016 9,016 Reserves/R.E./others 211 331 0 0 0 1,943 3,919 6,191 Shareholders' equity 3,780 4,406 5,317 6,178 9,016 10,958 12,935 15,207 Minority interests 98 97 121 135 134 133 132 130 Total equity & liabilities 5,401 7,012 8,654 9,650 13,398 16,965 19,569 23,016 EV 41,175 41,105 40,951 40,349 39,823 39,880 38,948 38,129 Net debt/(cash) (852) (870) (1,013) (1,577) (2,124) (1,945) (2,756) (3,453) BVPS (CNY) 3.487 4.064 4.904 5.698 7.670 9.323 11.004 12.937

 Key ratios (%) Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016E Sales (YoY) 56.9 75.3 21.4 1.1 22.7 44.4 11.6 18.6 EBITDA (YoY) 28.5 60.2 34.8 (3.6) 26.8 51.3 12.5 14.9 Operating profit (YoY) 27.4 61.0 40.1 (4.8) 28.7 52.6 11.5 14.5 Net profit (YoY) 25.7 60.5 39.0 3.1 20.1 58.3 11.0 14.0 Core EPS (fully-diluted) (YoY) 25.7 60.5 39.0 3.1 18.3 48.3 11.0 14.0 Gross-profit margin 36.3 36.9 35.0 33.2 35.1 36.1 36.1 35.4 EBITDA margin 20.8 19.0 21.1 20.1 20.8 21.8 21.9 21.3 Operating-profit margin 18.1 16.6 19.2 18.1 19.0 20.0 20.0 19.3 Net profit margin 16.0 14.6 16.7 17.1 16.7 18.3 18.2 17.5 ROAE 14.8 20.8 24.4 21.2 19.3 23.3 21.6 20.9 ROAA 11.1 13.7 15.1 13.3 12.7 15.3 14.1 13.8 ROCE 15.7 20.7 23.0 19.0 19.3 22.4 20.9 20.4 ROIC 18.0 25.1 29.0 24.6 24.4 27.2 25.2 25.3 Net debt to equity net cash net cash net cash net cash net cash net cash net cash net cash Effective tax rate 14.4 13.9 14.0 12.7 13.9 13.5 13.5 13.5 Accounts receivable (days) 135.7 97.8 99.6 147.9 177.4 171.0 190.3 185.0 Current ratio (x) 2.5 2.2 2.2 2.4 2.8 2.5 2.6 2.6 Net interest cover (x) n.a. 279.3 49.7 n.a. n.a. n.a. n.a. n.a. Net dividend payout 39.8 38.8 31.1 31.1 24.2 25.9 25.9 25.9 Free cash flow yield n.a. 0.9 2.1 2.0 1.0 1.4 3.7 3.9 Source: FactSet, Daiwa forecasts

 Company profile Zhuzhou CSR Times Electric sells and manufactures train-borne electrical systems and electrical components. The company also engages in application research and engineering research of electric traction technology, and industrial and civilian converter technology. It designs and manufactures electrical control equipment for locomotives, rapid transit vehicles, passenger cars and railway maintenance machinery, as well as power electronics devices, sensors, vacuum sewage collectors, general inverters and intelligent traffic.

- 32 - China Railway Sector 9 January 2015

is a subsidiary of CSR, there will be some competition between ZZCSR and the merged entity. ZZCSR has been granted an option that enables it, at its discretion at any time, to require the merged entity to sell the competing business, and ZZCSR has the first right to buy the competing business if the merged A key beneficiary of entity sells it. CSR/CNR merger IGBTs – growth potential in non- ZZCSR is our top pick in our China rail segment Railway universe given its potential to increase its market share by providing IGBTs are a kind of power electronic device for electrical energy conversion and control. additional MU components to CNR. ZZCSR is also a beneficiary of China’s ZZCSR’s trial production of 8-inch IGBTs is likely increase in railway equipment FAI. progressing well, making it the first China company that will have complete design, manufacturing and assembly capabilities. As with most other Potential as a component semiconductor products, the production yield will likely be small in the first few years, and we estimate provider to CNR this IGBT business will not register any meaningful contribution in 2015-16. 2017E EPS could see about 30% upside if we factor in potential contribution from In the longer run, however, we estimate revenue from CNR IGBTs could reach CNY2bn a year. Mass production is At our recent meeting with ZZCSR’s management, it likely to start in or after 2017; ZZCSR currently has indicated that because of the differences in technology production capacity of 120,000 8-inch slices of IGBT platforms deployed by CSR and CNR, in the past wafers and 1 million pieces of IGBT modules. ZZCSR has not provided high-margin locomotives and MU components to CNR. However, ZZSCR believes it We see the IGBT business as a potential growth could gain the ability to produce components to CNR business for ZZCSR in the non-rail segment, driven by by making adjustments to its current technology energy-efficient appliances, electric vehicles and solar platform. power, etc., other than high speed rail applications.

As CRC is pushing for a unification of national Upon mass production, ZZCSR’s management believes technology standards in order to reduce its vehicle China will achieve the domestication of IGBT chip maintenance costs, we believe the planned merger production and break the domination of foreign between CSR and CNR could speed up the unification enterprises in the high-end IGBT market. progress. By our estimates, ZZCSR’s 2017E EPS could rise by about 30% relative to our current forecast if we factor in the potential for ZZCSR to provide MU Beneficiary of upwardly revised components to CNR. FAI and CSR’s large backlog and delivery schedule CSR/CNR merger plan We see ZZCSR as a beneficiary of both an increase we expect China to announce in 1Q15 to its railway CSR and CNR announced on 30 December 2014 plans equipment FAI target for 2015, and CSR’s large order to merge via a share swap, in the ratio of 1 CNR share backlog and delivery schedule. for 1.1 CSR share. The merged entity will be renamed

CRRC Corporation Limited (CRRC). CSR, as ZZCSR’s largest customer, has in past years

accounted for about 70% the latter’s profits, on our Given certain subsidiaries of CNR, including those in estimates. With concentrated deliveries of locomotives control systems, traction power supply and braking and MUs for CSR, we believe ZZCSR should receive systems, overlap with the businesses of ZZCSR, which more orders for key components going forward from

- 33 - China Railway Sector 9 January 2015

parent CSR. We estimate the components that ZZCSR  ZZCSR: revenue breakdown 100% 5% 5% 4% 5% 5% provides to CSR on average account for about 12% of 7% 6% 4% 3% 3% 90% 10% the selling price of MUs and 17% of that for 13% 10% 9% 80% 14% 5% 5% 5% 7% locomotives. We believe ZZCSR is set to benefit from 70% 9% 11% 15% 11% 21% parent CSR’s high backlog coverage ratio (as illustrated 60% 13% 50% 37% in our analysis on CSR that forms part of this sector 26% 36% 40% 31% 35% report). 30% 20% 33% 30% We forecast ZZCSR’s high-margin train power control 10% 22% 26% 22% 0% systems to contribute 77% of the company’s total 2012 2013 2014E 2015E 2016E revenue for 2014E, up from only 70% in 2013, and Locomotive EMU high-speed train Metro cars Train operation safety equipment driven mainly by a high number of deliveries of Railway maintenance vehicles related Power semiconductor components locomotives, MUs and metro cars. We forecast revenue Others from its train power control systems to rise at a CAGR Source: Company, Daiwa forecasts of 15% for 2014-16E.

Among the 3 major products for which ZZCSR provides Financials power systems, we believe metro car products will see the highest revenue growth over the next 2 years. We We forecast ZZCSR’s revenue to rise by a strong 44% forecast 50% YoY volume growth for both 2015 and YoY for 2014, 12% YoY for 2015 (following an 2016 for ZZCSR’s urban transit rail segment, outpacing exceptionally high growth rate in 2014E) and 19% YoY its parent CSR’s urban transit product volume growth for 2016, driven by parent CSR’s concentrated delivery of 30% YoY for the same 2 years, mainly because schedule of MUs, locomotives and metro cars products. tenders for the bidding of subway cars and related power systems are typically done separately. ZZCSR’s We forecast ZZCSR’s net profit to increase by 11% YoY strengths in technology and market share in metro for 2015 and 14% YoY for 2016. We project its gross power systems should lead it to gain substantial market margin to improve to 36.1% for 2014E (from 35.1% in share and secure metro power systems bids in the 2013), due to a more favourable product mix and future, even if the metro cars are manufactured by CNR greater economies of scale. at present. ZZCSR has maintained a net cash position since its IPO In addition, we believe ZZCSR stands to benefit from in 2006, which puts the company in a strong position potential market share gains by CSR in international for future expansion and potential acquisitions, in our markets following CSR’s planned merger with CNR. view. Its total liability/total asset ratio remained at a healthy level of 32% in 2013, up from 25% since its  ZZCSR: revenue and net profit listing, due to its fast expansion over the past few years. (CNYm) (% ) 20,000 70% We estimate accounts receivable days climbed to 171 60% days in 2014 and forecast them to remain at a high 15,000 50% level for the next 3 years, from 99 days in 2010 due to the high gearing ratio of CRC, the major customer of 40% 10,000 ZZCSR’s parent CSR. Still, given ZZCSR’s net cash 30% position, we do not foresee pressure on the company’s 5,000 20% working capital requirements. We forecast free cash 10% flow of CNY589m for 2014E, CNY1,560m for 2015E, 0 0% and CNY1,560m for 2016E, which should position the 2012 2013 2014E 2015E 2016E company well for further expansion in the future. Revenue Net Profit Revenue YoY % Net Profit YoY % Source: Company, Daiwa forecasts

- 34 - China Railway Sector 9 January 2015

 ZZCSR: income statement (CNYm except otherwise indicated) 2012 2013 2014E 2015E 2016E Valuation and recommendation Locomotive products 1,584 2,906 3,808 3,651 3,651 YoY growth -28.5% 83.5% 31.0% -4.1% 0.0% EMU high-speed train products 2,229 2,315 4,630 5,093 5,883 As with the other China railway players in our coverage YoY growth -12.2% 3.9% 100.0% 10.0% 15.5% universe, we value ZZCSR on a PER basis and using Metro cars products 928 956 1,338 2,107 3,477 our EPS forecast for 2016. YoY growth 87.5% 3.0% 40.0% 57.5% 65.0% Train operation safety equipment 613 571 628 691 760 We set a 12-month target price of HKD58, based on our YoY growth 39.4% -6.9% 10.0% 10.0% 10.0% Railway maintenance vehicles related products 976 1,103 1,301 1,432 1,575 2016 EPS forecast and assigning a target PER of 18.5x, YoY growth 63.5% 13.0% 18.0% 10.0% 10.0% which is at 1SD above its past-5-year trading average Power semiconductor components 490 523 444 489 538 PER of 15x. YoY growth -1.8% 6.8% -15.0% 10.0% 10.0% Sensors and related products 102 0 0 0 0 YoY growth -5.3% -100.0% 0.0% 0.0% 0.0% Our target price implies a 2015E PER of 21.1x. We have Others 233 407 529 688894 not factored in the potential positive impact of the YoY growth 23.1% 0.0% 30.0% 30.0% 30.0% merger of CSR and CNR into our EPS forecasts for Net revenue 7,154 8,781 12,679 14,151 16,778 ZZSCR given this merger has to receive shareholder YoY growth 1.1% 22.7% 44.4% 11.6% 18.6% and regulatory approvals. We estimate that our EPS for COGS (4,781) (5,695) (8,101) (9,043) (10,837) Gross profit 2,373 3,086 4,578 5,108 5,941 2016E could see about 30% upside from our current YoY growth -4.3% 30.1% 48.3% 11.6% 16.3% forecast if we factor in the merger impact, and hence Gross margin 33.2% 35.1% 36.1% 36.1% 35.4% would imply upside to our current target price. Our SG&A (1,190) (1,504) (2,114) (2,360) (2,798) target price implies a 14.3x PER based on our Other operating income/expense 110 82 76 85 101 EBITDA 1,439 1,825 2,761 3,106 3,567 appraised 2016E EPS (factoring in additional orders YoY growth -3.6% 26.8% 51.3% 12.5% 14.9% for MU from CNR post-merger), which is slightly below EBITDA margin 20.1% 20.8% 21.8% 21.9% 21.3% ZZCSR’s past-5-year average forward PER. Depreciation (128) (138) (162) (192) (223) Amortisation (18) (22) (59) (80) (102) Our target price implies 29.9% upside potential. We EBIT 1,293 1,664 2,539 2,833 3,243 YoY growth -4.8% 28.7% 52.6% 11.5% 14.5% initiate coverage of ZZCSR with a Buy (1) rating, EBIT margin 18.1% 19.0% 20.0% 20.0% 19.3% backed by strong share-price upside potential we see Interest income 11 21 24 25 33 and the drivers analysed in this report. Interest expense (2) 7 (0) (0) (0) Profit/loss from assets sales - (1) - - - Investment income 99 13 120 120 120 Pre-tax income 1,401 1,704 2,683 2,978 3,396 YoY growth 1.4% 21.6% 57.5% 11.0% 14.0% Pre-tax income margin 19.6% 19.4% 21.2% 21.0% 20.2% Income tax (178) (237) (362) (402) (458) Effective tax rate (%) 12.7% 13.9% 13.5% 13.5% 13.5% Minority interests (I/S item) (1) 1 1 1 2 Net income, post-exceptionals 1,221 1,467 2,322 2,577 2,939 YoY growth 3.1% 20.1% 58.3% 11.0% 14.0% Net margin 17.1% 16.7% 18.3% 18.2% 17.5% Post-tax exceptionals - - - - - Net income, pre-exceptionals 1,221 1,467 2,322 2,577 2,939 YoY growth 3.1% 20.1% 58.3% 11.0% 14.0% Net margin 17.1% 16.7% 18.3% 18.2% 17.5% Source: Company, Daiwa forecasts    ZZCSR: valuation model and sensitivity analysis Valuation Sensitivity analysis of target price (HKD) 2016E EPS (CNY) 2.50 PER (x) 18.5 PER (x) Exchange rate, 1HKD = x CNY 0.80 12.5 14.5 16.5 18.5 20.5 22.5 24.5 Equity value/share (HKD/share) 58.00 0.82 38.0 44.0 50.0 56.0 63.0 69.0 75.0 Current price (HKD) 44.65 0.81 39.0 45.0 51.0 57.0 63.0 69.0 76.0 29.9% 39.0 45.0 52.0 58.0 64.0 70.0 77.0

Potential share price upside/downside (%) FX 0.80 Implied target 2015E PER (x) 21.1 0.79 40.0 46.0 52.0 59.0 65.0 71.0 78.0 Appraised 2016E EPS (CNY) 3.25 0.78 40.0 46.0 53.0 59.0 66.0 72.0 79.0

Implied target PER on appraised 16E EPS (x) 14.3 Source: Daiwa estimates and forecasts

- 35 - China Railway Sector 9 January 2015

 ZZCSR: PER bands (HKD) Company background 24x 20x 16x 45 Historical Avg PER: 14.3x 40 ZZCSR, listed on the Hong Kong Stock Exchange in 35 12x 2006, is a leading train-borne electrical system 30 provider and integrator for China’s railway industry. It 25 8x is also engaged in the manufacturing and sale of train 20 power converters, auxiliary power supply equipment 15 4x and control systems for locomotives, MUs and RTVs. 10 5 In addition, ZZCSR designs, manufactures and sells 0 electrical components for both the railway industry and non-railway applications. Headquartered in Zhuzhou, Jul-09 Jul-10 Jul-11 Jul-12 Jul-13 Jul-14 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15

Hunan, the company is a subsidiary of CSR. Source: Company, Daiwa ZZCSR’s original parent company, Zhuzhou Electric  ZZCSR: PBR bands Locomotive Research Institute (ZELRI), was founded (HK$) 3.8x 3.2x in 1959 as the research division under the Ministry of 45 Railways (MOR) to engage in the research and 40 Historical Avg PB: 2.8x 2.6x development of electric locomotives and related 35 products. In 1986, China National Railways 30 2.0x 25 Locomotive and Rolling Stock Industrial Corporation 20 1.4x (LORIC) was established under the MOR, and the 15 parent company ZELRI subsequently became a 0.8x 10 research division under LORIC. In 2002, LORIC was 5 divided into 2 entities upon the approval of the State 0 Council, namely CSR and CNR (which at the time held respective stakes of 51% and 49% in ZELRI). Jul-09 Jul-10 Jul-11 Jul-12 Jul-13 Jul-14 Apr-09 Oct-09 Apr-10 Oct-10 Apr-11 Oct-11 Apr-12 Oct-12 Apr-13 Oct-13 Apr-14 Oct-14 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15

Source: Company, Daiwa In 2007, the State-owned Assets Supervision and Administration Commission (SASAC) decided to Risks to our view transfer CNR’s 49% interest in ZELRI to CSR, making ZELRI a full subsidiary of CSR.

The main risk to our positive call on ZZCSR is a slower-  ZZCSR: revenue breakdown (2013) than-expected product delivery schedule. This would Power semiconductor Others dampen its revenue flow and thus imply downside to 4.6% components our earnings forecasts. 6.0% Railway maintenance Locomotive A secondary risk is slower margin improvements vehicles related 33.1% compared with our expectations. Greater economies of 12.6% scale likely brought about margin improvements for Train operation safety ZZCSR in 2014, on our forecasts. We expect solid equipment margin expansion in 2015-16 on the back of ongoing 6.5% economies of scale and a favourable product mix. A Metro cars slower-than-expected margin improvement would 10.9% EMU high-speed train lower our earnings forecasts for the company. 26.4% Source: Company A further secondary risk would be unexpected changes in regulatory policies and political risks.

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 ZZCSR: current shareholder structure

CSR Group

57.2%

CSR Corp (1766 HK)

100%

CSR Zhuzhou Electric Locomotive Research Kunming China Public shareholders Institute (ZELRI) Railway

46.6% 52.6% 0.8%

Zhuzhou CSR (3898 HK)

Source: Company, Daiwa

- 37 -

Industrials / China 1766 HK Industrials / China 9 January 2015

CSR Corp

CSR Corp Target (HKD): 13.30 Upside: 29.4% 1766 HK 7 Jan price (HKD): 10.28

Initiation: transforming into a rolling stock giant 1 Buy (initiation) 2 Outperform • CSR will have a monopoly on China’s railway equipment market 3 Hold and enjoy stronger pricing power post merger with CNR 4 Underperform • Should benefit from further growth in China’s train purchase 5 Sell FAI, on new HSR mileage and robust passenger throughput • Initiating with Buy (1) rating and target price of HKD13.30, based on a 15x PER on our pro-forma 2016E EPS

How do we justify our view?

products (56% of its 1H14 revenue) assuming a smooth integration of given its close historical correlation CNR. with railway FAI. CSR’s strong order backlog should also support ■ Risks business growth in 2015. Key risks: 1) slower-than-expected Brian Lam product deliveries, 2) slower-than- (852) 2532 4341 We also see a long-term business expected margin improvements, and [email protected] growth driver in the urban transit 3) regulatory and political risks. market, for which CCID Consulting Kelvin Lau forecasts mileage at 3,101km in (852) 2848 4467 2014, rising to 3,775km in 2015 and [email protected] 6,314km by 2018 (20% CAGR for Share price performance

2014-18E). CSR had a CNY42.3bn (HKD) (%) 13 190 backlog of rapid transit vehicle ■ Investment case 11 163 (RTV) products at end-1H14, and we We initiate coverage on CSR with a 9 135 forecast a 30% CAGR for its RTV- Buy (1) rating. CSR is 1 of China’s 2 7 108 related revenue for 2014-16. 5 80 main railway equipment Jan-14 Apr-14 Jul-14 Oct-14 Jan-15 manufacturers alongside CNR (Not ■ Catalysts rated) and will have a monopoly CSR Corp (LHS) Relative to HSI (RHS) We see near-term share price following its planned merger with catalysts from potentially strong CNR. We believe the merger will 12-month range 5.36-12.32 2014 results (due in March) and an Market cap (USDbn) 18.30 strengthen CSR’s pricing power increase that we expect China to 3m avg daily turnover (USDm) 18.04 domestically and overseas and thus announce (in 1Q15) in its railway Shares outstanding (m) 13,803 enhance its profitability potential, Major shareholder CSR Group (56.5%) FAI target for 2015. Details of the and bring market share gains 13th FYP expected to be announced overseas where CSR will no longer Financial summary (CNY) in 3Q15 could also underpin investor compete directly with CNR. Year to 31 Dec 14E 15E 16E sentiment towards CSR. Revenue (m) 122,034 134,133 150,163

Operating profit (m) 8,410 9,649 10,965 We expect China’s upcoming 13th 5- ■ Valuation Net profit (m) 5,823 6,694 7,628 Year Plan to support continuous Core EPS (fully-diluted) 0.422 0.485 0.553 Our 12-month target price is long-term railway equipment FAI EPS change (%) 40.7 15.0 14.0 HKD13.30, based on a 15x PER growth, backed by new demand for Daiwa vs Cons. EPS (%) 4.7 3.2 7.7 multiple-unit trains (MU) on (past-5-year forward average) PER (x) 19.5 17.0 14.9 applied to our pro-forma (ie, post- Dividend yield (%) 1.5 1.8 2.0 completion of new HSR mileage and merger) 2016E EPS of CNY0.71. DPS 0.127 0.146 0.166 robust passenger throughput growth PBR (x) 2.8 2.5 2.2 This assumes savings of 3% in SG&A on the existing HSR. This bodes well EV/EBITDA (x) 12.8 11.4 10.2 and 5% in R&D expenses and 1pp for CSR’s revenue from its railway ROE (%) 15.0 15.3 15.6 gross margin expansion in 2016, Source: FactSet, Daiwa forecasts

See important disclosures, including any required research certifications, beginning on page 80 China Railway Sector 9 January 2015

1 Buy (initiation) How do we justify our view? 2 Outperform

3 Hold  Growth outlook

4 Underperform  Valuation 5 Sell  Earnings revisions

 Growth outlook  CSR: net profit and net profit growth (2010-16E) For CSR on a standalone basis (ie, excluding CNR), we (CNYm) forecast net profit growth of 41% YoY to CNY5,823m for 9,000 60% 8,000 2014, mainly on the back of strong orders for MUs and 50% 7,000 locomotives from its largest domestic customer, China 6,000 40% Railway Corporation (CRC). 5,000 30% 4,000 Bearing in mind a high earnings comparison base for 3,000 20% 2014, we forecast CSR’s net profit growth to moderate to 2,000 10% still-solid rates of 15% YoY for 2015 and 14% YoY for 1,000 2016, driven by strong orders and deliveries of its high- 0 0% 2010 2011 2012 2013 2014E 2015E 2016E margin MUs and locomotive products, both in in its domestic market (notably for customer CRC), and Net Profit (LHS) Growth (YoY, RHS) Source: Company, Daiwa forecasts overseas business where we expect it to enjoy market Note: CSR standalone for all years (ie, excluding its proposed merger with CNR) share gains.

 Valuation  CSR: 12-month forward PER trend (x) CSR is trading currently at a PER of 17.0x for 2015E and PER 14.9x for 2016E (based on our EPS forecasts for CSR 30 standalone). Based on our pro forma 2016 EPS (ie, 25 including CNR), its current trading PER is 11.6x. +1 SD 20 Avg

We believe the market has yet to factor in fully the 15 -1 SD potential we see for CSR to strengthen its pricing power (domestically and overseas) and gain market share 10 overseas following its proposed merger with CNR. We 5 see good scope for a valuation rerating for CSR and Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Sep-09 Sep-10 Sep-11 Sep-12 Sep-13 Sep-14 expect this to crystallise fully after its merger with CNR May-09 May-10 May-11 May-12 May-13 May-14 completes. Trading PE Average +1 SD -1 SD Source: Company, Daiwa forecasts

 Earnings revisions  CSR: revisions to consensus 2015-16 EPS forecasts Our EPS forecasts 2014E, 2015E and 2016E (standalone (CNY) basis) are 5%, 3% and 8%, respectively, above the 0.49 Bloomberg consensus figures, reflecting our greater 0.47 optimism on CSR’s operational performance. We expect 0.45 to see consensus EPS increases when CSR reports its 0.43 2014 results in March, which we expect will be strong 0.41 and contain some share-price catalysts (for instance, 0.39 more details on China’s FAI target for 2015). 0.37 0.35 Jul-14 Oct-14 Apr-14 Jan-14 Jun-14 Mar-14 Feb-14 Aug-14 Sep-14 Nov-14 May-14 2015E 2016E Source: Bloomberg

- 39 - China Railway Sector 9 January 2015

 Key assumptions Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016E Total railway FAI (CNYm) 701,321 842,652 590,609 633,967 665,745 800,000 830,000 860,000 Train purchase investment(CNYm) 78,076 106,650 104,949 90,000 103,800 143,000 170,000 170,000 Locomotives volume growth (%) 111.8 31.2 (4.0) (42.4) 16.5 15.0 8.0 5.0 Pax carriage volume growth (%) 113.6 (19.4) 60.5 (8.2) (37.6) (5.0) (5.0) 0.0 Freight wagon volume growth (%) (33.6) 18.0 32.7 3.5 (9.1) (15.0) (15.0) 0.0 MUs volume growth (%) 28.9 89.8 21.5 6.2 (8.3) 100.0 10.0 10.0 RTV volume growth (%) 56.2 58.5 (5.9) 3.8 7.9 50.0 30.0 30.0

 Profit and loss (CNYm) Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016E Multiple units 7,932 14,628 20,981 21,524 19,189 39,528 45,769 53,869 Locomotives 14,102 18,019 17,803 14,396 19,846 22,723 24,585 25,934 Other Revenue 23,586 31,266 40,732 53,100 57,490 59,783 63,779 70,360 Total Revenue 45,621 63,912 79,517 89,019 96,525 122,034 134,133 150,163 Other income 491 144 501 665 888 488 537 601 COGS (38,454) (52,945) (64,647) (73,264) (79,896) (98,858) (108,388) (121,178) SG&A (5,396) (7,766) (9,752) (10,840) (11,647) (15,254) (16,632) (18,620) Other op.expenses 00000000 Operating profit 2,262 3,345 5,619 5,580 5,870 8,410 9,649 10,965 Net-interest inc./(exp.) (162) (225) (836) (532) (412) (465) (455) (433) Assoc/forex/extraord./others 302 545 659 545 476 400 400 400 Pre-tax profit 2,401 3,665 5,442 5,593 5,933 8,346 9,594 10,933 Tax (285) (415) (699) (740) (859) (1,209) (1,389) (1,583) Min. int./pref. div./others (438) (719) (879) (843) (934) (1,314) (1,511) (1,721) Net profit (reported) 1,678 2,531 3,864 4,009 4,140 5,823 6,694 7,628 Net profit (adjusted) 1,471 2,596 3,864 4,009 4,140 5,823 6,694 7,628 EPS (reported)(CNY) 0.142 0.214 0.326 0.299 0.300 0.422 0.485 0.553 EPS (adjusted)(CNY) 0.124 0.219 0.326 0.299 0.300 0.422 0.485 0.553 EPS (adjusted fully-diluted)(CNY) 0.124 0.219 0.326 0.299 0.300 0.422 0.485 0.553 DPS (CNY) 0.040 0.040 0.210 0.090 0.090 0.127 0.146 0.166 EBIT 2,262 3,345 5,619 5,580 5,870 8,410 9,649 10,965 EBITDA 3,275 4,627 7,157 7,363 7,811 10,721 12,178 13,712

 Cash flow (CNYm) Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016E Profit before tax 2,401 3,665 5,442 5,593 5,933 8,346 9,594 10,933 Depreciation and amortisation 1,013 1,282 1,538 1,783 1,941 2,311 2,529 2,746 Tax paid (269) (369) (568) (855) (968) (1,209) (1,389) (1,583) Change in working capital 1,111 (1,000) 130 (4,764) (2,034) (5,385) (2,686) (1,885) Other operational CF items 390 (113) 360 638 457 96 193 193 Cash flow from operations 4,646 3,465 6,902 2,394 5,329 4,158 8,240 10,403 Capex (4,779) (5,937) (6,197) (3,872) (4,580) (4,600) (4,600) (4,600) Net (acquisitions)/disposals 35 (182) 105 (1,328) (1,595) 0 0 0 Other investing CF items 203 490 (387) 954 (1,070) (4) 0 0 Cash flow from investing (4,541) (5,628) (6,479) (4,246) (7,245) (4,604) (4,600) (4,600) Change in debt (1,066) 2,120 4,305 (13,165) (9,653) (1,000) 0 0 Net share issues/(repurchases) 0 0 0 8,6990000 Dividends paid (379) 0 (474) (2,485) (1,242) (1,242) (1,747) (2,009) Other financing CF items 1,549 2,541 5,066 1,278 12,368 (1,102) (1,114) (1,164) Cash flow from financing 104 4,661 8,898 (5,672) 1,473 (3,344) (2,862) (3,172) Forex effect/others 00000000 Change in cash 208 2,498 9,322 (7,524) (444) (3,790) 779 2,631 Free cash flow (134) (2,472) 706 (1,478) 749 (442) 3,640 5,803 Source: FactSet, Daiwa forecasts

- 40 - China Railway Sector 9 January 2015

 Balance sheet (CNYm) As at 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016E Cash & short-term investment 11,273 13,771 21,976 14,452 14,009 10,219 10,998 13,629 Inventory 11,415 17,733 17,842 18,770 17,721 21,927 24,041 26,878 Accounts receivable 7,637 12,834 17,891 30,354 40,317 53,695 60,360 67,573 Other current assets 6,361 5,786 5,899 8,685 10,906 13,150 14,210 15,614 Total current assets 36,687 50,124 63,607 72,261 82,953 98,991 109,608 123,694 Fixed assets 13,509 17,066 21,374 22,971 25,201 26,961 28,548 29,961 Goodwill & intangibles 3,962 4,430 4,909 5,108 5,324 5,853 6,337 6,778 Other non-current assets 1,080 1,945 2,896 4,877 7,652 8,179 8,579 8,979 Total assets 55,238 73,566 92,786 105,217 121,129 139,983 153,072 169,411 Short-term debt 8,169 12,691 24,716 21,544 21,181 23,403 25,022 27,195 Accounts payable 13,676 17,972 21,239 26,715 31,798 39,345 43,138 48,228 Other current liabilities 8,222 12,000 13,230 13,280 14,021 17,691 19,432 21,738 Total current liabilities 30,067 42,662 59,185 61,538 67,000 80,439 87,591 97,161 Long-term debt 2,172 4,204 2,325 727 3,569 3,569 3,569 3,569 Other non-current liabilities 2,679 2,859 3,188 3,442 4,406 4,406 4,406 4,406 Total liabilities 34,917 49,725 64,698 65,707 74,975 88,413 95,566 105,136 Share capital 16,857 18,771 20,077 31,513 35,318 35,318 35,318 35,318 Reserves/R.E./others 474 474 2,485 1,242 1,242 5,823 10,770 16,389 Shareholders' equity 17,330 19,244 22,562 32,755 36,560 41,141 46,088 51,707 Minority interests 2,991 4,597 5,526 6,754 9,595 10,429 11,418 12,568 Total equity & liabilities 55,238 73,566 92,786 105,217 121,129 139,983 153,072 169,411 EV 114,891 120,283 122,195 125,673 131,054 137,500 138,930 139,222 Net debt/(cash) (933) 3,124 5,065 7,819 10,741 16,752 17,593 17,135 BVPS (CNY) 1.464 1.625 1.906 2.373 2.649 2.981 3.339 3.746

 Key ratios (%) Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016E Sales (YoY) 30.0 40.1 24.4 12.0 8.4 26.4 9.9 12.0 EBITDA (YoY) 12.6 41.3 54.7 2.9 6.1 37.3 13.6 12.6 Operating profit (YoY) 6.9 47.9 68.0 (0.7) 5.2 43.3 14.7 13.6 Net profit (YoY) 21.3 76.5 48.9 3.8 3.3 40.7 15.0 14.0 Core EPS (fully-diluted) (YoY) 21.3 76.5 48.9 (8.3) 0.2 40.7 15.0 14.0 Gross-profit margin 15.7 17.2 18.7 17.7 17.2 19.0 19.2 19.3 EBITDA margin 7.2 7.2 9.0 8.3 8.1 8.8 9.1 9.1 Operating-profit margin 5.0 5.2 7.1 6.3 6.1 6.9 7.2 7.3 Net profit margin 3.2 4.1 4.9 4.5 4.3 4.8 5.0 5.1 ROAE 8.8 14.2 18.5 14.5 11.9 15.0 15.3 15.6 ROAA 2.9 4.0 4.6 4.0 3.7 4.5 4.6 4.7 ROCE 8.0 9.4 11.7 9.5 8.8 11.3 11.7 12.1 ROIC 11.6 12.8 16.3 12.0 9.6 11.5 11.5 12.0 Net debt to equity n.a. 16.2 22.4 23.9 29.4 40.7 38.2 33.1 Effective tax rate 11.9 11.3 12.8 13.2 14.5 14.5 14.5 14.5 Accounts receivable (days) 56.1 58.5 70.5 98.9 133.6 140.6 155.2 155.5 Current ratio (x) 1.2 1.2 1.1 1.2 1.2 1.2 1.3 1.3 Net interest cover (x) 14.0 14.9 6.7 10.5 14.2 18.1 21.2 25.3 Net dividend payout 28.2 18.7 64.3 30.1 30.0 30.0 30.0 30.0 Free cash flow yield n.a. n.a. 0.6 n.a. 0.7 n.a. 3.2 5.1 Source: FactSet, Daiwa forecasts

 Company profile Established on 28 December 2007, CSR is one of China’s 2 manufacturers of rolling stock (alongside CNR, with which it proposes to merge in 2015) producing railway equipment and non-rail products. CSR’s key railway products include locomotives, passenger carriages, freight wagons and multiple-unit trains (MU). Its non-rail related products include rapid transit vehicles] (RTV) and wind-power equipment, electric buses, etc. CSR was listed on the stock exchanges of Shanghai and Hong Kong in August 2008.

- 41 - China Railway Sector 9 January 2015

no more than 10% of the total number of H-shares of each company individually. While there is a possibility that the merger won't go through, we believe it is very low give that the controlling shareholders of both entities are SOEs and current share prices appear to be pricing in a successful merger. Transforming into a We show how the shareholder structure of the merger rolling stock giant entity would look upon completion of the merger in the table below. We expect CSR to enjoy stronger pricing  Shareholding structure of merged entity upon CSR-CNR power in China and overseas, along with merger completion market share gains overseas on reduced (no. of shares) Shareholding Shareholding % A-share shareholders 22,917,692,293 83.98% competition following its proposed Of which: CSR 7,889,406,857 28.91% CNR 7,370,173,881 27.01% merger with domestic peer CNR. Also, Other A shareholders 7,658,111,555 28.06% CSR stands to benefit from China’s H-share shareholders 4,371,066,040 16.02% Total 27,288,758,333 100.00% railway FAI boom. Source: Companies, Daiwa

Various local media reports have stated that China’s Transforming into China’s rolling State-owned Assets Supervision and Administration stock leader with CNR merger Commission (SASAC) was behind the proposed merger between CSR and CNR in order to avoid both Merger plan with CNR: details companies competing directly with each other in the increasingly competitive overseas markets. 2015 is already shaping up to be a landmark year for CSR, whose proposed merger with its closest domestic What the merger means for CSR peer, CNR (announced on 30 December 2014) would lift CSR from being one of the 2 major manufacturers After the merger, the enlarged entity will become the in China’s duopoly market for railway equipment to the monopoly manufacturer in China’s railway equipment largest player in this market, thereby enhancing both market and will retain CRC as its single largest domestic its pricing power domestically and overseas and its customer. We expect the merged entity to have greater position in overseas markets. We describe the merger bargaining and pricing power in both HSR trains and the terms and illustrate its financial impact for CSR here. urban rail transit market, as it will become China’s only manufacturer of railway equipment and thus will have a CSR and CNR plan to merge through a share swap in monopoly. In addition, we believe the merger could bring the ratio of 1 CNR share for 1.1 CSR shares; the down R&D costs for the merged entity compared to the conversion ratio is the same for shareholders of CSR standalone CSR’s current R&D cost base. and CNR A-shares and H-shares. CNR will be delisted upon completion of the merger. The merged entity will In overseas markets, the merger will eliminate direct be renamed CRRC Corporation Limited (CRRC) and competition between CSR and CNR in the future, and will aim to increase its competitive position in overseas thus brings potential for the merged entity to lift both railway equipment markets. its market share and profit margins in overseas markets, in our view. Shareholders of A-shares and H-shares who object to the merger plan have the option of receiving cash Pro forma financials considerations of HKD7.32 for each CSR H-share and Our forecasts for CSR on the Financial summary pages HKD7.21 for each CNR H-share, and CNY5.63 for each of this report exclude CNR given the merger has yet to CSR A-share and CNY5.92 for each CNR A-share. complete. To illustrate how the CNR merger would influence our P&L and balance sheet forecasts for For the merger to proceed, other than the regulatory 2015E and 2016E, we show our forecasts for CSR on a approvals required from the SFC, Hong Kong Stock standalone basis alongside our pro forma forecasts for Exchange and the State Council of China, at the the merged entity in the following 2 tables. As can be shareholders’ meeting it will also require approval from seen, we believe the merger would be earnings- more than 75% of shareholders, and opposition from accretive for CSR.

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 CSR standalone vs. pro forma merged entity: P&L forecasts CSR standalone Pro forma - CRRC (CNYm) 2015E 2016E 2015E 2016E Revenue (net of business tax) 134,133 150,163 251,594 280,242 COGS (108,388) (121,178) (200,788) (223,347) Gross profit 25,745 28,985 50,806 56,896 YoY growth 11% 13% 17% 12% Gross-profit margin 19.2% 19.3% 20.2% 20.3% SG&A expenses (16,632) (18,620) (28,001) (31,202) Other operating income/expense 537 601 773 863 EBITDA 12,178 13,712 28,765 32,265 YoY growth 14% 13% 32% 12% EBITDA margin 9.1% 9.1% 11.4% 11.5% Depreciation (2,213) (2,387) (4,706) (5,146) Amortisation (315) (360) (480) (563) EBIT 9,649 10,965 23,578 26,556 YoY growth 15% 14% 38% 13% EBIT margin 7.2% 7.3% 9.4% 9.5% Interest income 138 160 743 837 Interest expense (593) (593) (2,269) (2,191) Profit/loss from assets sales - - - - Investment income 400 400 747 764 Other non-operating income (expense) - - - - Pre-tax income 9,594 10,933 22,799 25,966 YoY growth 15% 14% 42% 14% Pre-tax income margin 7.2% 7.3% 9.1% 9.3% Income tax (1,389) (1,583) (3,703) (4,217) Effective tax rate (%) 14.5% 14.5% 16.2% 16.2% Minority interests (I/S items) (1,511) (1,721) (2,052) (2,337) Net income, post-exceptional items 6,694 7,628 17,044 19,412 YoY growth 15% 14% 42% 14% Net margin 5.0% 5.1% 6.8% 6.9% Period-end shares outstanding (m) 13,803.0 13,803.0 27,288.8 27,288.8 EPS, basic - pre – exceptional items (CNY) 0.48 0.55 0.62 0.71 EPS, diluted - pre –exceptional items (CNY) 0.48 0.55 0.62 0.71 YoY growth 15% 14% n.m. 14% Source: Daiwa forecasts Note: for modelling purposes our pro-forma figures for 2015E assume full consolidation of CNR on 1 January 2015

 CSR standalone vs. pro forma merged entity: balance sheet forecasts (CNYm) CSR Pro forma-CRRC 2015E 2016E 2015E 2016E Cash and cash equivalents 10,997.7 13,628.7 26,811.6 31,672.9 Pledged and restricted bank balances 1,500.0 1,500.0 2,585.0 2,585.0 Non-pledged time deposits 900.0 900.0 2,033.0 2,033.0 Net receivables 60,359.7 67,573.4 99,171.6 110,554.5 Inventories 24,040.6 26,877.6 46,260.2 51,403.3 Other current assets 11,809.7 13,214.2 24,983.5 27,802.4 Total current assets 109,607.6 123,693.9 201,844.9 226,051.1 Net PP&E/fixed assets 28,547.8 29,961.0 60,424.5 63,378.6 Net intangibles 6,337.4 6,777.7 18,066.4 19,003.8 Associates & JCEs 4,492.5 4,892.5 7,243.8 8,007.6 Long-term deferred tax assets 586.2 586.2 1,037.2 1,037.2 Other long-term assets 3,500.0 3,500.0 13,029.7 13,029.7 Total assets 153,071.5 169,411.3 301,646.5 330,508.0 Accounts payable 43,137.6 48,228.1 86,088.8 95,637.3 Bills payable 18,415.9 20,589.1 18,415.9 20,589.1 Short-term debt 6,606.3 6,606.3 26,215.3 25,215.3 Other current liabilities 19,431.6 21,737.9 40,494.8 45,037.1 Total current liabilities 87,591.4 97,161.4 171,214.8 186,478.8 Long-term debt (excl. current portion) 3,568.5 3,568.5 4,983.8 4,983.8 Other long-term liabilities 4,406.1 4,406.1 9,580.5 9,580.5 Total non-current liabilities 7,974.6 7,974.6 14,564.3 14,564.3 Total liabilities 95,566.0 105,136.0 185,779.0 201,043.0 Total shareholders' equity 46,087.5 51,706.9 102,478.4 114,751.5 Minority interests 11,418.0 12,568.4 13,389.0 14,713.4 Total liabilities and equity 153,071.5 169,411.3 301,646.5 330,508.0 Source: Daiwa forecasts

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 CSR: order backlog breakdown (1H14) CSR’s strong order backlog Others 5.6% should support growth in 2015 Locomotives 25.6% Rapid transit Looking at CSR’s operations on a standalone basis, the vehicles company has a robust order backlog which we believe 29.5% will underpin its revenue growth in 2015. As at end- Passenger carriages 1H14, the company had a total locomotive backlog of 4.4% CNY36.7bn, of which CNY12.8bn was for South Africa, Freight wagons with deliveries expected to start in 2015. Its order 3.7% backlog for MUs totalled CNY44.8bn at end-1H14, of MUs which CNY21.2bn was attributable to Bombardier 31.2% Sifang (Qingdao) Transportation (BST), which is CSR’s Source: Company, Daiwa China-based joint venture owned 50%/50% with Canada-based transport equipment manufacturer  CSR: backlog coverage ratio by product segment Bombardier. (x) 2010 2011 2012 2013 1H14 Locomotives 0.9 0.4 0.3 0.4 1.6 In late-September 2014, CSR won orders in the China Passenger carriages 0.2 0.3 0.4 0.2 1.0 market for 57 sets of 250/km MUs and 93 sets of Freight wagons 0.3 0.4 0.5 0.3 0.6 MUs 3.8 1.8 1.5 3.2 1.1 350km/hr MUs. In that month too, and for the first RTVs 2.9 3.0 3.9 3.4 time since its listing (August 2008), CSR secured Others 0.4 0.4 0.3 0.2 0.2 orders in its domestic market for 10 more sets of Total 1.5 1.0 0.9 1.1 1.2 250km/hr MUs that are able to withstand very cold Source: Company, Daiwa temperatures and sandy conditions, and which have a total order value of CNY1.5bn. Scope to boost competitive We believe CSR’s high order backlog, and especially its position in lucrative overseas recent order wins for MUs, will support solid business markets growth in 2015. In addition, BST started deliveries of its CNY21.2bn worth of orders for its CRH380DL train at end-2014 and its delivery schedule for these trains Over recent years, CSR and CNR have been competing runs to some point through 2016. increasingly both with each other and with international rolling stock manufacturers in overseas In addition, CSR stands to benefit from China’s railway railway equipment markets. Following their planned FAI boom. We believe the China Government will merger, direct competition overseas for CSR from its continue to favour railway investment as a way of China-based rival will be eliminated. Also, our industry sustaining the country’s economic growth, given its research indicates that overseas markets are generally significance for infrastructure spending. We estimate lucrative for CSR. the country’s train purchase investment was up by a strong 38% YoY to CNY143bn for 2014, and forecast it CSR and CNR have yet to export a complete set of MUs to increase further by 5% YoY for 2015E and 10% YoY but are already major providers of locomotives and for 2016E. wagons in several overseas markets. We believe CSR is well placed to receive its first export order for a full set Also, we believe China’s upcoming 13th 5-Year Plan of MUs very soon. (details likely to be provided in 3Q15) is likely to support continuous long-term growth of railway The following charts display the major players’ shares equipment FAI in China, backed by new demand for of different types of rolling stock in overseas markets MUs upon completion of new HSR mileage and also by (ex-China) in terms of revenue for 2008-11 (the most robust passenger throughput growth on the existing recent period for which full data is available). HSR.

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 Alternating current locomotives: overseas market shares  Diesel locomotives: overseas market shares (2008-11) (2008-11) Others Others CNR 12.0% 10.0% Siemens 9.0% 5.0% Vossich CNR 4.0% 29.0% CSR 13.0% Transmashholding Transmashholding 10.0% 9.0%

CLW EMD 11.0% 11.0%

GE 28.0% Bombardier CSR DLW 11.0% 13.0% 25.0% Source: SCI Verkehr Source: SCI Verkehr Note: CLW = Chittaranjan Locomotive Works Note: GE = General Electric, DLW =Diesel Locomotive Works, EMD = Electro-Motive Diesel

 Passenger carriages: overseas market shares (2008-11)  Subway trains: overseas market shares (2008-11)

Others CNR Others CNR 15.0% 16.0% 19.0% 16.0%

Bombardia 4.0% Kawasaki 7.0% Transmashholding CSR CSR 11.0% 20.0% 18.0% Rotem 7.0%

ICF CAF 14.0% 8.0% Alstom RCF Bombardier 13.0% 20.0% 12.0% Source: SCI Verkehr Source: SCI Verkehr Note: ICF = Integral Coach Factory , RCF =Rail Coach Factory

Electric MUs: overseas market shares (2008-11)  Diesel MUs: overseas market shares (2008-11)

Alstom Others 15.0% 20.0% Bombardia Others 28.0% 27.0%

Siemens Bombardier 5.0% 15.0% Transmashholding 6.0% Siemens 7.0% ICF Kawasaki Stadler 7.0% 13.0% Rotem 11.0% 8.0% Stadler Alstom CAF PESA 10.0% 11.0% 8.0% 9.0% Source: SCI Verkehr Source: SCI Verkehr Note: PESA = Pojazdy Szynowe Pesa Bydgoszcz

In our view, CSR has a competitive advantage in some By way of illustration, in the following table we overseas markets for rolling stock which should compare the technical specifications for rolling stock increase upon its merger with CNR. Many countries between CSR and once of its main international have very constrained budgets for HSR projects, which competitors, Bombardier. As can be seen, the unit are capital-intensive. We believe this competitive edge prices of CSR’s rolling stock are at least 29% below stems from CSR’s cost advantage in being able to those of Bombardier’s (with a discount of up to 54% for manufacture rolling stock relatively cheaply in China high-speed MUs). then export it (this is the case too with CNR currently).

- 45 - China Railway Sector 9 January 2015

 CSR vs. Bombardier: contract prices of major products CSR vs. Bombardier CSR Bombardier Electric locomotives Item E464 HXD1C Particulars 3,500kW GTO 7,200kW IGBT 2x power Sold to Italy China Quantity 50 590 Amount original 186 8600 Unit price original 3.7 14.6 Unit price (CNYm) 23.4 14.6 38% discount Subway trains Item MOVIA Type A Particulars IGBT AC 80km/h IGBT AC 80km/h Similar Sold to India China Quantity 76 N/A Amount original 120 N/A Unit price original 1.6 7 Unit price (CNYm) 9.9 7 29% discount High-speed MUs Item REGINA CRH1A Particulars Prototype of CRH1 250km/h Similar Sold to Sweden China Quantity 18 320 Amount original 101 5,200 Unit price original 5.6 16.3 Unit price (CNYm) 35.4 16.3 54% discount Diesel locomotives Item TRAXX HXN5 Particulars 3,000 hp 6,000 hp 2x power Sold to Germany China Quantity 200 50 Amount original 867 880 Unit price original 4.3 17.6 Unit price (CNYm) 27.3 17.6 35% discount Source: Companies, Daiwa

- 46 - China Railway Sector 9 January 2015

We are less positive on CSR’s freight wagons segment Financials: CSR standalone due to the weak market outlook for coal. We forecast the company’s freight wagons to account for 10% of For CSR on a standalone basis, we forecast YoY revenue CSR’s total revenue for 2014E and see a YoY revenue growth of 26% to CNY122bn for 2014, 10% to CNY134bn decline of 13% for 2015E, and for it to be flat for 2016E. for 2015 and 12% to CNY150.1bn for 2016, driven mainly by strong demand for its high-margin MUs and RTVs. As for CSR’s other non-rail products, for 2014 Specifically, we forecast YoY revenue growth for the management has guided for high revenue growth for its company’s MUs of 16% for 2015E and 18% for 2016E. electric buses (a relatively new product). We expect this We expect more new order wins for MUs in 2015, which to be offset by stagnant revenue for its wind power should continue to drive revenue in 2016. products. Thus, for CSR’s non-rail products overall we forecast flat revenue for 2014E but steady revenue growth of 5% YoY for each of 2015E and 2o16E.   CSR standalone: income statement (CNYm except otherwise indicated) 2012 2013 2014E 2015E 2016E Locomotives 14,396 19,846 22,723 24,585 25,934 YoY growth -19.1% 37.9% 14.5% 8.2% 5.5% Passenger carriages 7,753 6,590 6,327 6,080 6,116 YoY growth 22.0% -15.0% -4.0% -3.9% 0.6% Freight wagons 10,420 9,932 8,363 7,258 7,258 YoY growth 7.5% -4.7% -15.8% -13.2% 0.0% MUs 21,524 19,189 39,528 45,769 53,869 YoY growth 2.6% -10.8% 106.0% 15.8% 17.7% Rapid transit vehicles 7,947 8,251 12,376 16,089 20,916 YoY growth -3.3% 3.8% 50.0% 30.0% 30.0% Others 26,980 32,717 32,717 34,353 36,070 YoY growth 63.8% 21.3% 0.0% 5.0% 5.0% Net revenue 89,019 96,525 122,034 134,133 150,163 Domestic 80,541 90,128 103,729 111,330 112,622 YoY growth 9.7% 11.9% 15.1% 7.3% 1.2% As % of total revenue 90.5% 93.4% 85.0% 83.0% 75.0% International 8,479 6,397 18,305 22,803 37,541 YoY growth 38.9% -24.6% 186.2% 24.6% 64.6% As % of total revenue 9.5% 6.6% 15.0% 17.0% 25.0% Net revenue 89,019 96,525 122,034 134,133 150,163 YoY growth 12.0% 8.4% 26.4% 9.9% 12.0% COGS (73,264) (79,896) (98,858) (108,388) (121,178) Gross profit 15,755 16,629 23,177 25,745 28,985 YoY growth 6.0% 5.5% 39.4% 11.1% 12.6% Gross margin 17.7% 17.2% 19.0% 19.2% 19.3% SG&A expenses (10,840) (11,647) (15,254) (16,632) (18,620) Other operating income/expense 665 888 488 537 601 EBITDA 7,363 7,811 10,721 12,178 13,712 YoY growth 2.9% 6.1% 37.3% 13.6% 12.6% EBITDA margin 8.3% 8.1% 8.8% 9.1% 9.1% Depreciation (1,566) (1,708) (2,040) (2,213) (2,387) Amortization (217) (232) (271) (315) (360) EBIT 5,580 5,870 8,410 9,649 10,965 YoY growth -0.7% 5.2% 43.3% 14.7% 13.6% EBIT margin 6.3% 6.1% 6.9% 7.2% 7.3% Interest income 232 134 157 138 160 Interest expense (764) (546) (622) (593) (593) Profit/loss from asset sales 4 112 - - - Investment income 541 364 400 400 400 Other non-operating income (expense) - - - - - Pre-tax income 5,593 5,933 8,346 9,594 10,933 YoY growth 2.8% 6.1% 40.7% 15.0% 14.0% Pre-tax income margin 6.3% 6.1% 6.8% 7.2% 7.3% Income tax (740) (859) (1,209) (1,389) (1,583) Effective tax rate (%) -13.2% -14.5% -14.5% -14.5% -14.5% Minority interests (I/S item) (843) (934) (1,314) (1,511) (1,721) Net income 4,009 4,140 5,823 6,694 7,628 YoY growth 3.8% 3.3% 40.7% 15.0% 14.0% Net margin 4.5% 4.3% 4.8% 5.0% 5.1% ROE 14.5% 11.9% 15.0% 15.3% 15.6% ROA 4.0% 3.7% 4.5% 4.6% 4.7% SG&A/revenue 12.2% 12.1% 12.5% 12.4% 12.4% EBIT interest coverage ratio (x) 7.3 10.7 13.5 16.3 18.5 Source: Company, Daiwa forecasts

- 47 - China Railway Sector 9 January 2015

We forecast CSR’s revenue contribution to its total revenue from refurbishment work to increase to 11% in Valuation and recommendation 2016E, from about 7-8% in 2014E, as we believe more level 4 and 5 (ie, the higher levels of maintenance and As with the other companies in our China Railway refurbishment work needed for trains after they have coverage, we value CSR on a PER basis. run for long distances) maintenance work for its MUs will be required by then. Currently, only lower 1-3 We have a 12-month target price for CSR of HKD13.30, levels of maintenance work (which are easier to carry derived by assigning a 15x PER, in line with CSR’s past- out and do not require dismantling the trains) can be 5-year average trading PER, and which we apply to our conducted by the railway operators. pro-forma (ie, post-merger) 2016 EPS forecast of CNY0.71. We use our post-merger 2016 EPS forecast as  CSR standalone: revenue and net profit we believe investors will increasingly value CSR based (CNYm) (% ) on the company’s perceived earnings potential 160,000 50% following its planned merger with CNR. Our pro-forma 140,000 2016 EPS forecast assumes reductions of 3% in SG&A 40% 120,000 expenses and 5% in R&D costs and 1pp gross margin 100,000 30% expansion for the merged entity post-synergies versus 80,000 CSR’s and CNR’s combined financials pre-synergies, 20% 60,000 assuming a smooth merger integration and hence 40,000 10% higher margins across the board for the merged entity. 20,000 0 0%  CSR: merger synergy assumptions (2016E) 2012 2013 2014E 2015E 2016E (in CNYm) As a % of total 2016E Revenue Net Profit Total synergies 3,994 Revenue YoY % Net Profit YoY % SG&A cost savings 3.0% 642 Source: Company, Daiwa forecasts R&D cost savings 5.0% 550 Gross margin expansion 1.0% 2,802

 CSR standalone: revenue breakdown by product segment Source: Daiwa estimates 100% 90% 27% 26% 24% 30% 34% Our target price implies a 21.9x PER for 2015E. We 80% illustrate the sensitivity of our target price to variations in 70% 14% 9% 10% 12% 60% 9% PERs and HKD/CNY exchange rates in the following table. 50% 24% 20% 32% 34% 36% 40% 30% 12% 10%  CSR: valuation model and sensitivity analysis of target price 7% 7% 5% 5% 20% 9% 5% 5% 4% to PER and HKD/CNY exchange rate variations 10% 16% 21% 19% 18% 17% 2016E EPS post merger (CNY)* 0.71 0% PER (x) 15.0 2012 2013 2014E 2015E 2016E Exchange rate, 1HKD = x CNY 0.80 Locomotives Passenger carriages Freight wagons Target equity value/share (HKD) 13.30 MU Rapid transit vehicles Others Current share price (HKD) (7 Jan ’15) 10.28 Share price upside potential (%) 29.4% Source: Company, Daiwa forecasts

2015E EPS standalone (CNY) 0.48 The company’s COGS has little exposure to fluctuations Implied target 2015E PER (X) 21.9 in commodity and steel prices. We estimate that steel Sensitivity analysis of valuation PER (x) costs account for only 5-6% of its total COGS annually. 9.0 11.0 13.0 15.0 17.0 19.0 21.0 Costs for its spare parts, for which pricing depends 0.82 7.8 9.5 11.3 13.0 14.7 16.5 18.2 heavily on individual technology specifications, 0.81 7.9 9.7 11.4 13.2 14.9 16.7 18.4

FX FX 0.80 8.0 9.8 11.6 13.3 15.1 16.9 18.7 account for most of the company’s annual COGS. 0.79 8.1 9.9 11.7 13.5 15.3 17.1 18.9 0.78 8.2 10.0 11.9 13.7 15.5 17.3 19.2

We forecast CSR (standalone) to see net profit growth of Source: Daiwa estimates and forecasts 41% YoY for 2014, driven mainly by strong orders for Note: * Our target price is based on our pro-forma EPS for 2016E MUs and locomotives from its largest domestic customer, CRC. Due to a high YoY comparison base for Based on our standalone EPS forecasts, CSR is trading 2014E, we forecast its YoY net profit growth to moderate currently at a PER of 17.0x for 2015E and 14.9x for 2016E to still-sound rates of 15% for 2015E and 14% for 2016. (vs. its average forward PER of 17x since listing in August We believe it should be able to maintain its ROE at a 2008). Based on our pro-forma 2016 EPS forecast, high level of 15.3% for 2015E and 15.6% for 2016E. however, CSR is trading at only an 11.6x PER, pointing to scope for a rerating over the coming months, in our view.

- 48 - China Railway Sector 9 January 2015

Our target price implies 29% share price upside potential. We initiate coverage of CSR with a Buy (1) Company background rating, premised upon the drivers discussed in this report and a valuation that we consider as attractive. CSR was established on 28 December 2007 and was listed on the Shanghai Stock Exchange and Hong Kong  CSR: PER bands Stock Exchange in August 2008.

(HKD) Historical Avg PER since listing: 17x 12 24x 20x CSR is one of China’s 2 major manufacturers of rolling stock (alongside CNR, with which it plans to merge) in 10 16x what is currently a duopoly domestic market, 8 12x producing railway equipment and other non-rail 6 products. The company’s key railway products include 8x locomotives, passenger carriages, freight wagons and 4 4x MUs. Its non-rail related products include RTVs, wind 2 power equipment, electric buses, etc. 0 CSR’s parent company is China South Locomotive & Feb-09 Feb-10 Feb-11 Feb-12 Feb-13 Feb-14 Aug-08 Nov-08 Aug-09 Nov-09 Aug-10 Nov-10 Aug-11 Nov-11 Aug-12 Nov-12 Aug-13 Nov-13 Aug-14 Nov-14 May-09 May-10 May-11 May-12 May-13 May-14 Rolling Stock Industry Group Corp. (CSR Group), Source: Daiwa which together with China North Locomotive & Rolling Stock Group were spun off from China Locomotive &  CSR: PBR bands Rolling Stock Industrial Corp (LORIC) in 2002. (HKD) 4.2x LORIC, established in 1986, was originally the General 16 Historical Avg PBR: 2.2x 3.4x 14 Manufacturing Bureau of the former Ministry of 12 Railways (MOR). CSR Group is CSR’s largest 2.6x 10 shareholder, with a 56.5% stake currently.

8 1.8x CSR owns 52.6% of subsidiary Zhuzhou CSR (ZZCSR: 6 1.0x 3898 HK, HKD44.65, Buy [1]), which sells and 4 0.6x manufactures train-borne electrical systems and 2 electrical components of rolling stocks to CSR and 0 other companies. We also provide an analysis of ZZCSR as part of our China Railway Sector report. Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Sep-09 Sep-10 Sep-11 Sep-12 Sep-13 Sep-14 May-09 May-10 May-11 May-12 May-13 May-14 Source: Daiwa  CSR: revenue breakdown by product (2013)

Locomotives Risks 20.6% Others 33.9% We see the main risk to our positive investment thesis on CSR as a slower-than-expected product delivery Pax carriages schedule. This would reduce the company’s revenue 6.8% stream and thus imply downside to our earnings forecasts. Freight wagons 10.3% Rapid transit A secondary risk would be slower margin vehicles improvements in the event of lower synergies than we 8.5% MU 19.9% expect from CSR’s merger with CNR. This would curb our earnings forecasts for CSR. Source: Company Note: Pax = passenger

A further secondary risk would be unexpected changes in regulatory policies and political risks.

- 49 -

Industrials / China 390 HK Industrials / China 9 January 2015

China Railway Group

China Railway Group Target (HKD): 7.50 Upside: 21.6% 390 HK 7 Jan price (HKD): 6.17

Initiation: Riding the wave of China’s railway FAI upcyle 1 Buy (initiation) 2 Outperform • Deriving some 40% of its revenue from railway construction, 3 Hold CRG is an immediate beneficiary of China’s railway FAI boom 4 Underperform • The company is set to benefit from higher FAI in urban rail 5 Sell transit, driven by urbanisation, overseas market exposure • We initiate with a Buy (1) call and 12-month target price of HKD7.5, based on 9.5x 2016E PER

How do we justify our view?

backed by growing investment in ■ Risks HSR/urban rail transit. We believe Key risks to our view: 1) regulatory its existing new contracts/backlog risk from changes in the coverage are sufficient to support its government’s railway policy, and 2) earnings growth through 2015-16. political risks and lower-than-than Brian Lam expected margins on overseas (852) 2532 4341 We are also positive on China’s business. [email protected] urban rail transit market because of ongoing urbanisation; our forecasts Kelvin Lau call for 24% and 13% YoY growth in (852) 2848 4467 urban rail transit investment in 2015 [email protected] and 2016, respectively. CRG has Share price performance

expertise in constructing subways, (HKD) (%) 7.0 170 ■ Investment case which we believe could be a long- term earnings driver. We estimate 6.0 148 We believe CRG stands to benefit 5.0 125 the cost of HSR construction in from China’s railway FAI boom. We 4.0 103 China is about two-thirds of the estimate China’s total railway FAI 3.0 80 average cost in other countries. Jan-14 Apr-14 Jul-14 Oct-14 Jan-15 grew by 20% YoY to CNY800bn for 2014. From this high base, we Given China’s policy to support the Ch Rail Gp (LHS) Relative to HSI (RHS) export of HSR products, we expect forecast railway FAI growth of 4% YoY for both 2015/16. CRG is one investor sentiment to remain strong. 12-month range 3.02-6.62 half of the duopoly in China’s Market cap (USDbn) 16.95 ■ Catalysts 3m avg daily turnover (USDm) 26.92 railway construction market (the Strong full-year 2014 results (due in Shares outstanding (m) 21,300 other player being CRCC), and has a Major shareholder ina Railway Engineering Group (56.1%) 40-45% market share. Historically, March 2015) and a formal announcement of China’s railway it has derived some 40% of its Financial summary (CNY) construction revenue from railway FAI target for 2015 could serve as Year to 31 Dec 14E 15E 16E construction. near-term catalysts for the shares. Revenue (m) 611,027 674,948 744,573 We believe full details of the 13th FYP Operating profit (m) 20,547 21,918 23,253 Net profit (m) 11,056 12,323 13,509 The NDRC had approved 64 new would also boost the stock. Core EPS (fully-diluted) 0.519 0.579 0.634 railways construction projects as at EPS change (%) 32.3 11.5 9.6 ■ Valuation end-Nov 2014, which we believe will Daiwa vs Cons. EPS (%) 5.3 5.6 7.5 provide a sufficient order backlog for We initiate on CRG with a Buy (1) PER (x) 9.5 8.5 7.8 Dividend yield (%) 1.6 1.8 1.9 railway constructors. We forecast rating and 12-month target price of HKD7.5, based on 9.5x 2016E PER, DPS 0.078 0.087 0.095 the value of new contracts for CRG PBR (x) 1.1 1.0 0.9 in line with its past-5-year average to grow by 11%, 9% and 8% YoY in EV/EBITDA (x) 9.1 8.8 8.4 2014, 2015 and 2016, respectively, multiple. Our target price implies a ROE (%) 12.1 12.1 12.0 2015E PER of 10.4x. Source: FactSet, Daiwa forecasts

See important disclosures, including any required research certifications, beginning on page 80 China Railway Sector 9 January 2015

1 Buy (initiation) How do we justify our view? 2 Outperform

3 Hold  Growth outlook

4 Underperform  Valuation 5 Sell  Earnings revisions

 Growth outlook  CRG: net profit and net profit growth (2010-2016E) We look for CRG’s net profit to grow 32% YoY to (CNYm) CNY11.1bn in 2014. From this high base, we forecast 16,000 35% earnings growth of 11% YoY for 2015 and 10% YoY for 14,000 30% 12,000 25% 2016, driven by an order backlog domestically (Central 20% 10,000 and Western China) and in overseas markets, and 15% 8,000 supported by the government’s favourable policies. 10% 6,000 5% 4,000 0% 2,000 (5%) 0 (10%) 2010 2011 2012 2013 2014E 2015E 2016E Net Profit (LHS) Growth (YoY, RHS) Source: Company, Daiwa forecasts

 Valuation  CRG: forward PER On our forecasts, CRG is trading at PERs of 8.5x for PER 2015E and 7.8x for 2016E, which are below its past-5- 20 year average multiple of 10x. Our target price of +1 SD HKD7.5, which is based on 9.5x 2016E PER, implies a 15 2015E PER of 10.4x, on our forecast. Avg 10 +1 SD 5

0 Jul-09 Jul-10 Jul-11 Jul-12 Jul-13 Jul-14 Apr-09 Oct-09 Apr-10 Oct-10 Apr-11 Oct-11 Apr-12 Oct-12 Apr-13 Oct-13 Apr-14 Oct-14 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Trading PE Average +1 SD -1 SD Source: Company, Daiwa forecasts

 Earnings revisions  CRG: revision to consensus EPS forecast

Compared with the Bloomberg consensus forecasts, we (CNY) are more optimistic on CRG’s operating performance. 0.60 Our EPS forecasts for 2014,2015 and 2016 are respectively 5%, 6% and 8% above the consensus 0.55 numbers. 0.50

0.45

0.40 Jul-14 Apr-14 Oct-14 Jun-14 Jan-14 Feb-14 Mar-14 Aug-14 Sep-14 Nov-14 May-14 FY15E FY16E Source: Bloomberg

- 51 - China Railway Sector 9 January 2015

 Key assumptions Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016E China railway infra FAI (CNY m) 600,564 707,459 461,084 518,506 532,770 620,000 640,000 650,000 China railway infra FAI % 78.1 17.8 (34.8) 12.5 2.8 16.4 3.2 1.6 New contracts (CNY m) 601,800 735,480 570,800 731,000 929,650 1,033,846 1,122,564 1,215,929 New contracts % 40.5 22.2 (22.4) 28.1 27.2 11.2 8.6 8.3

 Profit and loss (CNYm) Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016E Construction 309,279 411,716 385,202 390,037 445,952 516,274 588,558 658,104 Survey, Design and Consultancy 6,798 8,330 8,357 8,447 8,560 9,244 9,799 10,387 Other Revenue 19,282 38,862 52,213 70,310 87,643 85,509 76,591 76,081 Total Revenue 335,359 458,908 445,772 468,794 542,154 611,027 674,948 744,573 Other income 00000000 COGS (314,547) (431,204) (412,033) (431,754) (501,843) (563,365) (623,078) (688,279) SG&A (12,506) (17,208) (21,758) (23,708) (25,322) (27,115) (29,951) (33,041) Other op.expenses 0 0 0 00000 Operating profit 8,305 10,496 11,981 13,332 14,989 20,547 21,918 23,253 Net-interest inc./(exp.) (1,648) (1,756) (3,130) (4,484) (4,638) (4,852) (4,526) (4,150) Assoc/forex/extraord./others 1,987 1,683 750 1,743 3,161 188 300 300 Pre-tax profit 8,645 10,423 9,600 10,591 13,511 15,883 17,693 19,403 Tax (1,236) (2,213) (2,361) (2,557) (3,435) (4,039) (4,499) (4,934) Min. int./pref. div./others (521) (813) (550) (679) (701) (788) (871) (961) Net profit (reported) 6,887 7,397 6,690 7,355 9,375 11,056 12,323 13,509 Net profit (adjusted) 6,071 7,119 7,164 6,868 8,358 11,056 12,323 13,509 EPS (reported)(CNY) 0.323 0.347 0.314 0.345 0.440 0.519 0.579 0.634 EPS (adjusted)(CNY) 0.285 0.334 0.336 0.322 0.392 0.519 0.579 0.634 EPS (adjusted fully-diluted)(CNY) 0.285 0.334 0.336 0.322 0.392 0.519 0.579 0.634 DPS (CNY) 0.063 0.055 0.048 0.052 0.066 0.078 0.087 0.095 EBIT 8,305 10,496 11,981 13,332 14,989 20,547 21,918 23,253 EBITDA 12,831 15,601 18,340 19,511 21,701 27,649 29,736 31,974

 Cash flow (CNYm) Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016E Profit before tax 8,645 10,423 9,600 10,591 13,511 15,883 17,693 19,403 Depreciation and amortisation 4,526 5,105 6,359 6,179 6,712 7,102 7,818 8,721 Tax paid (1,236) (2,213) (2,361) (2,557) (3,435) (4,039) (4,499) (4,934) Change in working capital 6,801 (13,389) (30,495) (22,089) (12,694) (9,954) (8,945) (10,196) Other operational CF items 1,222 1,051 3,336 3,664 3,827 (1,515) (2,131) (2,168) Cash flow from operations 19,957 977 (13,560) (4,213) 7,920 7,477 9,936 10,827 Capex (16,345) (14,788) (10,418) (9,636) (9,969) (12,600) (12,000) (11,500) Net (acquisitions)/disposals 2,005 1,424 1,093 1,082 943 0 0 0 Other investing CF items (2,224) (3,051) (2,387) (3,421) (3,138) 1,015 879 709 Cash flow from investing (16,563) (16,414) (11,712) (11,976) (12,163) (11,585) (11,121) (10,791) Change in debt 2,886 27,382 37,914 34,014 25,059 (3,577) 10,787 860 Net share issues/(repurchases) 0 0 0 00000 Dividends paid 0 (1,342) (1,173) (1,022) (1,108) (1,406) (1,658) (1,848) Other financing CF items (3,680) (5,122) (6,143) (9,319) (11,788) (5,979) (5,328) (4,784) Cash flow from financing (794) 20,918 30,598 23,672 12,164 (10,962) 3,801 (5,773) Forex effect/others 00000000 Change in cash 2,600 5,481 5,327 7,484 7,921 (15,070) 2,615 (5,737) Free cash flow 3,612 (13,811) (23,978) (13,849) (2,049) (5,123) (2,064) (673) Source: FactSet, Daiwa forecasts

- 52 - China Railway Sector 9 January 2015

 Balance sheet (CNYm) As at 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016E Cash & short-term investment 49,447 54,927 60,254 67,738 75,658 60,589 63,204 57,467 Inventory 25,273 31,704 36,329 41,906 46,581 53,118 59,188 65,335 Accounts receivable 132,433 166,310 199,996 160,458 190,716 226,294 258,787 292,987 Other current assets 30,697 45,609 63,324 164,563 189,933 207,056 223,646 240,771 Total current assets 237,850 298,550 359,902 434,664 502,889 547,057 604,825 656,558 Fixed assets 28,552 34,101 37,267 41,311 44,084 49,144 52,911 55,299 Goodwill & intangibles 24,747 31,252 41,191 40,917 40,944 41,381 41,796 42,188 Other non-current assets 21,424 27,867 30,373 33,836 40,284 41,481 42,664 43,951 Total assets 312,573 391,770 468,732 550,728 628,201 679,063 742,196 797,997 Short-term debt 31,639 45,104 70,392 94,244 107,100 87,711 87,711 87,711 Accounts payable 169,543 205,222 224,327 244,402 277,637 316,776 352,829 389,976 Other current liabilities 9,318 14,655 10,853 27,473 35,507 39,860 44,084 48,698 Total current liabilities 210,500 264,981 305,571 366,120 420,243 444,347 484,625 526,385 Long-term debt 27,151 44,394 73,606 87,899 102,399 117,399 127,399 127,399 Other non-current liabilities 8,166 8,106 8,205 8,146 8,759 9,610 10,437 11,339 Total liabilities 245,817 317,481 387,382 462,165 531,401 571,356 622,460 665,123 Share capital 21,300 21,300 21,300 21,300 21,300 21,300 21,300 21,300 Reserves/R.E./others 40,036 45,849 50,720 57,064 65,334 74,983 85,648 97,308 Shareholders' equity 61,336 67,149 72,020 78,364 86,633 96,283 106,948 118,608 Minority interests 5,420 7,140 9,330 10,199 10,167 11,424 12,788 14,266 Total equity & liabilities 312,573 391,770 468,732 550,728 628,201 679,063 742,196 797,997 EV 112,135 138,846 191,334 222,028 240,152 252,203 260,952 268,166 Net debt/(cash) 9,343 34,571 83,744 114,405 133,840 144,521 151,906 157,643 BVPS (CNY) 2.880 3.153 3.381 3.679 4.067 4.520 5.021 5.568

 Key ratios (%) Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016E Sales (YoY) 47.6 36.8 (2.9) 5.2 15.6 12.7 10.5 10.3 EBITDA (YoY) 32.4 21.6 17.6 6.4 11.2 27.4 7.5 7.5 Operating profit (YoY) 27.7 26.4 14.1 11.3 12.4 37.1 6.7 6.1 Net profit (YoY) 43.9 17.3 0.6 (4.1) 21.7 32.3 11.5 9.6 Core EPS (fully-diluted) (YoY) 43.9 17.3 0.6 (4.1) 21.7 32.3 11.5 9.6 Gross-profit margin 6.2 6.0 7.6 7.9 7.4 7.8 7.7 7.6 EBITDA margin 3.8 3.4 4.1 4.2 4.0 4.5 4.4 4.3 Operating-profit margin 2.5 2.3 2.7 2.8 2.8 3.4 3.2 3.1 Net profit margin 1.8 1.6 1.6 1.5 1.5 1.8 1.8 1.8 ROAE 10.3 11.1 10.3 9.1 10.1 12.1 12.1 12.0 ROAA 2.2 2.0 1.7 1.3 1.4 1.7 1.7 1.8 ROCE 6.8 7.3 6.2 5.4 5.2 6.6 6.8 6.8 ROIC 9.6 8.9 6.6 5.5 5.2 6.3 6.2 6.2 Net debt to equity 15.2 51.5 116.3 146.0 154.5 150.1 142.0 132.9 Effective tax rate 14.3 21.2 24.6 24.1 25.4 25.4 25.4 25.4 Accounts receivable (days) 128.1 118.8 150.0 140.3 118.2 124.6 131.2 135.2 Current ratio (x) 1.1 1.1 1.2 1.2 1.2 1.2 1.2 1.2 Net interest cover (x) 5.0 6.0 3.8 3.0 3.2 4.2 4.8 5.6 Net dividend payout 19.5 15.9 15.3 15.1 15.0 15.0 15.0 15.0 Free cash flow yield 3.4 n.a. n.a. n.a. n.a. n.a. n.a. n.a. Source: FactSet, Daiwa forecasts

 Company profile China Railway Group is one part of the duopoly in China’s railway construction market, with a domestic market share of 40- 45%. The company also engages in design, survey and construction work for other infrastructure assets, such as roads, the urban rapid transit system, water conservancy, and hydropower facilities construction, and has manufacturing, property development, toll road operation, and mining businesses.

- 53 - China Railway Sector 9 January 2015

Sufficient backlog to support growth into15E/16E

As at the end of November 2014, NDRC had approved Immediate beneficiary 64 railway new construction projects, most of which it approved between October and November. We forecast of China’s railway FAI new contracts value for CRG to grow by 11.2%, 8.6%, and 8.3% YoY in 2014, 2015, and 2016, respectively, boom backed by the growth in HSR and urban rail transit investment, but offset by slower growth in local government-funded projects, such as roads and CRG is one part of the duopoly in China’s property-related business. We believe CRG’s existing railway construction market, with a new contracts and backlog coverage are sufficient to support CRG’s revenue growth through 2015 and 2016. market share of 40-45%. For 2014, we estimate total railway FAI grew by 20%  CRG: new contract value YoY to CNY800bn. From this high base, (CNYm) 1,400,000 28.1% 27.2% 30% we look for 4% YoY growth for both 2015 1,215,929 1,200,000 1,122,564 25% 1,033,846 and 2016. 1,000,000 929,650 20% 800,000 731,000 15% One part of the duopoly in railway 600,000 8.6% 8.3% 10% construction 400,000 11.2% 200,000 5% 0 0% As one part of the duopoly in China’s railway 2012 2013 2014E 2015E 2016E construction market, CRG stands to be an immediate New contract YoY % beneficiary of the upcycle in the China government’s Source: Company, Daiwa forecasts railway infrastructure FAI, in our view. Historically, the company derived some 40% of its construction  CRG: order backlog revenue from railway construction. Hence, China’s (CNYm) railway infrastructure FAI is closely correlated to the 3,500,000 35% railway construction revenue of CRG. 31.8% 3,000,000 2,992,080 30% 2,544,544 th 2,500,000 23.0% 23.5% 25% We believe China’s 13 Five-year Plan, which should be 2,118,521 2,000,000 1,715,250 20% announced in 3Q15, is likely to call for long-term stable 20.1% growth in the national railway build-out, as part of a 1,500,000 1,301,026 17.6% 15% broader effort to limit downside in country’s economic 1,000,000 10% growth. 500,000 5%

 Railway FAI in previous Five-year Plans: target vs actual 0 0% spending 2012 2013 2014E 2015E 2016E Backlog YoY % (CNYm) 4,000 Source: Company, Daiwa forecasts 3,500 3,000 We are also positive on China’s urban rail transit 2,500 market because of ongoing urbanisation. We forecast 2,000 24% YoY growth in urban rail transit investment for 1,500 2015 and 13% YoY growth for 2016. Because CRG has proven expertise in constructing subways, we believe it 1,000 will benefit from such investment, which we see being a 500 long-term driver of earnings for the company. 0 10th FYP 11th FYP 12th FYP Railway FAI - Original Target Railway FAI - Actual/Expected Investment Source: CRC, Daiwa

- 54 - China Railway Sector 9 January 2015

Robust overseas growth Operations and financials

In our view, China’s railway constructors are well One of China’s leading construction companies, CRG placed to compete in overseas markets, as on our focuses on infrastructure construction in railways, estimates the cost of HSR construction in China is roads, urban rapid transit systems, and water about two-thirds of the average cost in other countries. conservancy projects, among others. We estimate the Given the recent news flow on China’s policies to construction business contributed 82% of CRG’s total support the export of HSR products (during Prime revenue and 72% of its EBIT in 2014, backed by the Minister Li Keqiang’s visit overseas, he promoted railway investment upcycle, margin expansion, and China’s HSR products and mentioned policies to growth in its overseas construction business. support China companies that build infrastructure projects overseas; see the main section of this report), Railway construction business we expect investors’ sentiment on the sector to remain Given the railway FAI upcycle, our forecasts call for strong. CRG’s revenue from railway construction to grow by 25%

for 2014, 20% YoY for 2015, and 15% YoY for 2016. In 1H14, CRG’s overseas new contract value grew by However, we forecast CRG’s revenue growth from road 165% YoY and accounted for 7.5% of the total value of construction to moderate to 5% YoY for each of 2014- its new contracts, up from only 3.2% a year earlier. 16, given the high debt levels of local governments and Although its overseas revenue grew only 11% YoY in resulting funding issues. Meanwhile, its revenue from 1H14 and 1% YoY in 2013, we look for such growth to municipal works construction, where entry barriers are accelerate given the increase in the value of new higher, should be stable at 10% YoY over 2014-16, on contracts. We forecast CRG’s overseas revenue to grow our forecasts. by 44% YoY in 2014, 44% YoY in 2015, and 36% YoY in 2016. Surveying, design and consultancy business  CRG: growth in value of overseas contracts CRG also provides construction surveying, design and (CNYm) consultancy services to government and state-owned 250,000 80% businesses, on a standalone basis or in conjunction 70% with its construction business. We estimate this 200,000 60% business contributed 1.0% of CRG’s total revenue and 3% 150,000 50% of its EBIT for 2014; more than 80% of its revenue 40% from the survey, design and consultancy business 100,000 30% comes from services provided for railway construction 20% 50,000 projects, on our forecast. 10% 0 0% 2012 2013 2014E 2015E 2016E Manufacturing business New contract - overseas YoY growth CRG’s manufacturing business centres on large track

Source: Company, Daiwa forecasts maintenance machinery in China and Asia. We believe revenue growth in the manufacturing business will  CRG: growth in overseas revenue accelerate as CRG benefits from the upcycle in railway (CNYm) investment and railway system upgrades. We estimate 70,000 50% revenue in this segment accounted for 2.0% of CRG’s total revenue and 3% of EBIT for 2014E, and we 60,000 40% forecast a 15% CAGR in such revenue for 2014-16. 50,000 30% 40,000 Property business 30,000 20% CRG’s property business contributed about 5% of the 20,000 10% company’s total revenue and 10% of the EBIT for 10,000 2014E. Given the slowdown in China’s property sector, 0 0% we forecast CRG’s revenue from this segment to decline 2012 2013 2014E 2015E 2016E by 20% YoY in 2015 and a further 10% YoY in 2016. Revenue - overseas YoY growth Source: Company, Daiwa forecasts

- 55 - China Railway Sector 9 January 2015

 CRG: EBIT contribution investments and is responsible for the daily 100% management of the fund. 16% 90% 22% 18% 24%  CRG: key assumptions 4% 80% 4% 3% (CNYm unless otherwise indicated) 2012 2013 2014E 2015E 2016E 3% 3% 50% 3% 3% 70% 3% Construction revenue 390,037 445,952 516,274 588,558 658,104 YoY growth 1% 14% 16% 14% 12% 60% Railway 170,297 195,556 244,445 293,334 337,334 75% 78% YoY growth -10% 15% 25% 20% 15% 50% 70% 72% 6% Road 70,680 72,139 75,746 79,533 83,510 40% 6% YoY growth -3% 2% 5% 5% 5% 38% Municipal works (mostly subway) 149,059 178,257 196,083 215,691 237,261 30% YoY growth 21% 20% 10% 10% 10% 2012 2013 2014E 2015E 2016E Construction Survey & Design Manufacturing Others Gross margin: 8.8% 8.5% 8.5% 8.9% 9.0% Source: Company, Daiwa forecasts Railway 8.1% 6.4% 7.2% 7.6% 7.8% Road 7.4% 7.3% 6.5% 6.5% 6.5%  CRG: revenue contribution Municipal work 10.2% 11.2% 11.0% 11.5% 11.5% EBIT margin: 1.5% 5.5% 5.4% 4.9% 5.0% 100% New contract 536,700 731,270 826,087 906,324 990,553 95% 12% 11% 15% YoY growth 30% 36% 13% 10% 9% 16% 17% 90% Backlog 1,053,230 1,385,790 1,695,603 2,013,369 2,345,818 2% YoY growth 17% 32% 22% 19% 17% 2% 1% Survey & Design & Consultancy 85% 2% 1% 8,447 8,560 9,244 9,799 10,387 2% 1% revenue 2% 2% 80% 2% YoY growth 1.1% 1.3% 8.0% 6.0% 6.0% 84% 86% Gross margin 34.5% 35.1% 35.0% 35.0% 35.0% 82% 75% 81% 80% New contract 10,610 13,530 14,207 14,207 14,207 70% YoY growth 2.5% 27.5% 5.0% 0.0% 0.0% 2012 2013 2014E 2015E 2016E Backlog 16,740 20,970 25,932 30,340 34,159 Construction Survey & Design Manufacturing Others YoY growth 15.8% 25.3% 23.7% 17.0% 12.6% Source: Company, Daiwa forecasts Manufacturing revenue 9,059 11,322 13,020 14,973 17,219 We forecast CRG’s core earnings for 2014-16 to grow YoY growth -0.7% 25.0% 15.0% 15.0% 15.0%

18%, 11% and 10% YoY, respectively, backed by strong Gross margin 21.7% 21.0% 22.0% 22.0% 22.0% construction revenue growth but offset by declining contributions from the property business. Any policy- New contract 16,940 18,570 22,284 25,627 29,471 easing measures affecting the property sector in China YoY growth 3.2% 9.6% 20.0% 15.0% 15.0% Backlog 15,620 19,370 28,634 39,288 51,539 in 2015 would be an upside risk to our forecasts. YoY growth 38.8% 24.0% 47.8% 37.2% 31.2%

We estimate CRG’s gearing (debt/equity) at 150% in Other operations revenue 76,449 94,611 92,036 83,211 82,683 2014, but forecast it to decline to 142% in 2015 and YoY growth 31.7% 23.8% -2.7% -9.6% -0.6%

133% in 2016 as a result of our expectation of higher Gross margin 17.3% 16.4% 18.5% 17.4% 16.5% earnings contributions from railway construction. Its Real estate development 31.2% 30.3% 29.0% 27.0% 25.0% ROE should hold at 12% for 2014-16, on our forecasts. Mining 60.0% 25.8% 30.0% 30.0% 30.0% At the current share price, CRG offers dividend yields Other 11.8% 10.3% 13.0% 13.0% 13.0% of 1.6% and 1.8% for 2014E and 2015E, respectively. Source: Company, Daiwa forecasts

With reference to CRG’s high gearing but improving balance sheet, we believe the company has sufficient working capital for its construction projects as long as it does not become involved in too many BT/BOT projects in the future. Given that China established the Railway Development Fund in September 2014 with the goal of attracting private investment to the railway sector, we believe funding for the increasing railway FAI should not be a concern. According to the guidelines, the Fund serves as a market entity for railway investment and financing, while the China Railway Corporation (CRC) represents government

- 56 - China Railway Sector 9 January 2015

Valuation and recommendation Risks to our call

We initiate coverage of CRG with a Buy (1) rating and The main risk to our call would be regulatory risk, as 12-month target price of HKD7.5, based on a 2016E CRG’s revenue relies highly on China’s railway FAI PER of 9.5x, which is in line with the stock’s past-5- target. Any unfavourable changes in the country’s year average PER. Our target price implies a 2015E railway policy would have a severe impact on CRG. PER of 10.4x, on our forecasts. We find CRG is trading currently on PERs of 8.5x for 2015E and 7.8x for A secondary consideration would be political risks as 2016E, and offers a 1.6% dividend yield for 2014E. CRG expands overseas, especially in those new markets where it has less experience (also because overseas Our positive view on CRG is mainly due to the legal and regulatory requirements differ to those in following factors: 1) its duopoly position in China’s China). railway construction market and hence its status as a likely beneficiary of China’s railway infrastructure FAI upcycle, 2) a likely acceleration in domestic railway new orders in 2015E, and 3) robust revenue growth in overseas markets, supported by favourable government policies, as indicated by CRG’s new contract growth and high backlog coverage.

 CRG: valuation PER valuation 2016E Earnings (Pre-exceptional) 13,509 PER 10.0 PER (x) Equity value (CNYm) 128,333 6.5 7.5 8.5 9.5 10.5 11.5 12.5 Exchange rate, 1HKD=X CNY 0.80 0.82 5.0 5.8 6.6 7.3 8.1 8.9 9.7 Equity value (HKD m) 160,417 0.81 5.1 5.9 6.7 7.4 8.2 9.0 9.8 21,300

Number of shares (m) FX 0.80 5.2 5.9 6.7 7.5 8.3 9.1 9.9 Equity value/share (HKD) 7.50 0.79 5.2 6.0 6.8 7.6 8.4 9.2 10.0 Share price (HKD) 6.17 0.78 5.3 6.1 6.9 7.7 8.5 9.4 10.2 Potential upside/downside (%) 21.6%

Implied 2015E PER 10.4 Source: Daiwa forecasts

 CRG: PER band  CRG: PBR band (HK$) (HK$) Historical Avg PER: 10x Historical Avg PB: 1.0x 2.4x 12 17x 12 2x 1.6x 10 14x 10

8 11x 8 1.2x

6 8x 6 0.8x 4 5x 4 2 2 0.4x 2x 0 0 Jul-09 Jul-10 Jul-11 Jul-12 Jul-13 Jul-14 Jul-09 Jul-10 Jul-11 Jul-12 Jul-13 Jul-14 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Source: Bloomberg Source: Bloomberg

- 57 - China Railway Sector 9 January 2015

 CRG: EBIT contribution (2013) Company background Others CRG is one part of the duopoly in China’s railway 23.9% construction market, with a 40-45% market share in China. The company also engages in design, survey and Manufacturing construction work for other infrastructure assets, 2.6% including road, urban rapid transit, water conservancy, and hydropower facilities construction. It also has Survey & manufacturing, property development and toll road Design 3.0% Construction operation interests in China, a mining business in 70.4% Inner Mongolia, and some copper and cobalt mines in the Congo.

Source: Company In 2013, construction contributed 80% of CRG’s total revenue and 70% of its total EBIT. Revenue from railway construction accounted for 35% of its total revenue in the same year. Most of CRG’s construction contracts are fixed-price contracts, under which the company is responsible for procuring raw materials, including steel and cement, and therefore could expose the company to rising commodity price risk.

In view of the higher margins in other non- construction segments, and as part of an effort to mitigate the company’s reliance on the China government’s railway FAI policies, management has diversified the business into other non-construction segments, including property development. As of 1H14, CRG had a landbank totalling 39.6m sq m. Its property business accounted for 3.8% of total revenue and 10.2% of total gross profit in 1H14.

CRG was ranked No. 3 globally in 2013 by ENR (a magazine for the construction engineering industry) in terms of its construction contracting revenue. CRG’s parent is China Railway Engineering Group, which has a 56% stake in the company.

 CRG: revenue contribution (2013)

Others Manufacturing 16.9% 2.0%

Survey & Design 1.5%

Construction 79.6%

Source: Company

- 58 -

Industrials / China 1186 HK Industrials / China 9 January 2015

China Railway Construction

China Railway Construction Target (HKD): 11.70 Upside: 20.2% 1186 HK 7 Jan price (HKD): 9.73

Initiation: Another way to play China’s railway FAI plans 1 Buy (initiation) 2 Outperform • As one half of the China railway construction duopoly, CRCC 3 Hold also stands to benefit from the boom in China’s railway FAI 4 Underperform • It should also benefit from higher FAI on urban rail transit, 5 Sell though recent share placement means near-term dilution • We initiate with a Buy (1) call and 12-month target price of HKD11.70, based on a 9.5x 2016E PER

How do we justify our view?

thirds of the average cost in other ■ Risks countries. And given China’s policy Key risks to our view: 1) regulatory to support the export HSR products, risk from changes in the we expect investor sentiment to government’s railway policy, and 2) remain strong. political risks and lower-than-than Brian Lam expected margins on overseas (852) 2532 4341 CRCC has announced the non-public business. [email protected] issuance of A shares, the proceeds of which would be used to fund 4 Kelvin Lau BT/BOT projects and repay loans. (852) 2848 4467 Assuming the full placement raises [email protected] CNY9.9bn, we forecast circa 9% EPS Share price performance

dilution, which could result in near- (HKD) (%) 10.5 145 ■ Investment case term share-price weakness. 9.3 129 We believe CRCC is an immediate 8.0 113 ■ Catalysts beneficiary of China’s railway FAI 6.8 96 We highlight strong 2014 results boom. As one part of the duopoly in 5.5 80 Jan-14 Apr-14 Jul-14 Oct-14 Jan-15 China’s railway construction market, (due in March 2015) and an (the other being CRG), CRCC has a announcement of the government’s Ch Rail Co (LHS) Relative to HSI (RHS) 40-45% market share. Historically, railway FAI target for 2015 as potential near-term catalysts for the 12-month range 5.63-10.34 the company has derived around th 40% of its construction revenue stock. Details of China’s 13 Five- Market cap (USDbn) 15.48 3m avg daily turnover (USDm) 25.47 from railway construction. Year Plan, which is likely to be announced in 3Q15, could also Shares outstanding (m) 12,338 Major shareholder CRC Group (61.3%) We forecast the value of new enhance investor sentiment. contracts for CRCC to grow by an Financial summary (CNY) ■ Valuation average of 5% YoY in 2015-16, Year to 31 Dec 14E 15E 16E backed by HSR and urban rail We initiate on CRCC with a Buy (1) Revenue (m) 622,405 671,921 706,560 rating and 12-month target price of Operating profit (m) 19,966 21,919 24,101 transit construction. Reflecting our Net profit (m) 11,536 12,319 13,576 positive view of China’s urban rail HKD11.70, based on a 9.5x 2016E PER, which in line with the stock’s Core EPS (fully-diluted) 0.935 0.898 0.990 transit market amid ongoing EPS change (%) 11.5 (4.0) 10.2 urbanisation, we forecast urban rail past-5-year average. Our target price Daiwa vs Cons. EPS (%) 0.3 (10.4) (8.4) transit investment to grow by 24% implies a 2015E PER of 10.5x. Our PER (x) 8.3 8.7 7.9 Dividend yield (%) 1.9 1.8 2.0 YoY in 2015 and 13% YoY in 2016. 2015-16 EPS forecasts are respectively 10.4% and 8.4% below DPS 0.150 0.144 0.158 PBR (x) 1.1 1.0 0.9 consensus, probably because the A- We estimate the cost of HSR EV/EBITDA (x) 5.8 5.7 5.5 construction in China is about two- share placement has not yet been ROE (%) 13.4 12.2 11.6 factored in by the consensus. Source: FactSet, Daiwa forecasts

See important disclosures, including any required research certifications, beginning on page 80 China Railway Sector 9 January 2015

1 Buy (initiation) How do we justify our view? 2 Outperform

3 Hold  Growth outlook

4 Underperform  Valuation 5 Sell  Earnings revisions

 Growth outlook  CRCC: net profit and net profit growth (2010-16E) We forecast CRCC’s net profit to grow by 12% YoY for (CNYm) 2014, 7% YoY for 2015 and 10% YoY for 2016, driven 14,000 100% by a strong backlog both domestically in the central 12,000 80% western part of China and overseas, supported by the 10,000 60% 40% government’s favourable policy on railway 8,000 20% construction. 6,000 0% 4,000 (20%) 2,000 (40%) 0 (60%) 2010 2011 2012 2013 2014E 2015E 2016E Net profit (LHS) Growth (YoY, RHS) Source: Company, Daiwa forecasts

 Valuation  CRCC: forward PER

CRCC is trading at PERs of 8.7x for 2015E and 7.9x PER for 2016E, below its past-5-year trading average of 30 9.1x. Our target price of HKD11.70 is based on a 9.5x 25 2016E PER, and implies a 10.5x PER for 2015. 20 +1 SD

15 Avg 10 -1 SD 5

0 Jul-09 Jul-10 Jul-11 Jul-12 Jul-13 Jul-14 Apr-09 Oct-09 Apr-10 Oct-10 Apr-11 Oct-11 Apr-12 Oct-12 Apr-13 Oct-13 Apr-14 Oct-14 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Trading PE Average +1SD -1SD Source: Company, Daiwa forecasts

 Earnings revisions  CRCC: revisions to consensus EPS forecasts

Our EPS forecast for 2014 is largely in line with that (CNY) of the Bloomberg consensus. However, our EPS 1.05 forecasts for 2015-16 are 8-10% below consensus, as we do not think it has factored in the impact of the 1.00 forthcoming share dilution. 0.95

0.90

0.85 Jul-14 Apr-14 Oct-14 Jan-14 Jun-14 Feb-14 Mar-14 Aug-14 Sep-14 Nov-14 May-14 FY15E FY16E Source: Bloomberg

- 60 - China Railway Sector 9 January 2015

 Key assumptions Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016E China railway infra FAI (CNYm) 600,564.0 707,459.0 461,084.0 518,506.0 532,770.0 620,000.0 640,000.0 650,000.0 China railway infra FAI % 77.9 17.8 (34.8) 12.5 2.8 16.4 3.2 1.6 New contracts (CNYm) 601,327.1 747,198.3 681,179.0 789,337.0 853,483.5 897,147.4 938,089.9 980,899.0 New contracts % 42.1 24.3 (8.8) 15.9 8.1 5.1 4.6 4.6

 Profit and loss (CNYm) Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016E Construction 324,837 428,497 407,541 407,601 468,015 515,759 567,715 602,218 Survey, Design and Consultancy 7,638 8,333 7,464 7,287 7,761 8,538 8,964 9,413 Other Revenue 12,501 19,357 28,315 54,984 94,186 98,108 95,242 94,929 Total Revenue 344,976 456,187 443,319 469,872 569,962 622,405 671,921 706,560 Other income 00000000 COGS (322,428) (428,647) (409,327) (432,889) (527,248) (577,290) (624,210) (656,978) SG&A (13,990) (21,191) (22,158) (22,827) (26,433) (25,148) (25,792) (25,482) Other op.expenses 0 0 0 00000 Operating profit 8,558 6,349 11,834 14,156 16,282 19,966 21,919 24,101 Net-interest inc./(exp.) (675) (755) (2,093) (3,307) (3,790) (5,253) (6,244) (6,816) Assoc/forex/extraord./others 424 495 316 47 548 150 200 200 Pre-tax profit 8,307 6,089 10,056 10,896 13,040 14,863 15,875 17,484 Tax (1,576) (1,772) (2,174) (2,375) (2,600) (3,196) (3,413) (3,759) Min. int./pref. div./others (133) (70) (28) (42) (95) (132) (142) (149) Net profit (reported) 6,599 4,246 7,854 8,479 10,345 11,536 12,319 13,576 Net profit (adjusted) 6,118 6,958 7,771 8,479 10,345 11,536 12,319 13,576 EPS (reported)(CNY) 0.535 0.344 0.637 0.687 0.838 0.935 0.898 0.990 EPS (adjusted)(CNY) 0.496 0.564 0.630 0.687 0.838 0.935 0.898 0.990 EPS (adjusted fully-diluted)(CNY) 0.496 0.564 0.630 0.687 0.838 0.935 0.898 0.990 DPS (CNY) 0.160 0.100 0.100 0.110 0.130 0.150 0.144 0.158 EBIT 8,558 6,349 11,834 14,156 16,282 19,966 21,919 24,101 EBITDA 14,933 14,155 21,221 23,845 26,188 30,619 33,972 37,719

 Cash flow (CNYm) Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016E Profit before tax 8,307 6,089 10,056 10,896 13,040 14,863 15,875 17,484 Depreciation and amortisation 6,375 7,806 9,388 9,689 9,906 10,653 12,053 13,618 Tax paid (1,576) (1,772) (2,174) (2,375) (2,600) (3,196) (3,413) (3,759) Change in working capital 4,375 (6,805) (32,180) (15,818) (5,209) (18,048) (20,941) (13,514) Other operational CF items 355 702 2,109 3,173 (24,739) (741) 819 2,337 Cash flow from operations 17,837 6,019 (12,801) 5,565 (9,602) 3,532 4,393 16,166 Capex (12,998) (17,014) (12,054) (10,500) (17,645) (17,273) (18,273) (20,219) Net (acquisitions)/disposals 2,212 1,287 1,238 1,657 1,606 0 0 0 Other investing CF items (2,843) 202 213 534 (3,957) 79 (273) (26) Cash flow from investing (13,629) (15,525) (10,603) (8,309) (19,997) (17,194) (18,546) (20,246) Change in debt 3,981 13,930 46,307 17,318 35,906 11,580 (2,554) 197 Net share issues/(repurchases) 0 0 0 0 0 0 9,936 0 Dividends paid (1,224) (1,974) (1,234) (1,357) (1,604) (1,604) (1,846) (1,972) Other financing CF items (1,350) (1,597) (3,425) (5,038) (4,702) (7,092) (7,468) (7,373) Cash flow from financing 1,407 10,359 41,649 10,923 29,600 2,884 (1,933) (9,148) Forex effect/others 00000000 Change in cash 5,615 853 18,244 8,179 1 (10,778) (16,085) (13,228) Free cash flow 4,839 (10,995) (24,855) (4,935) (27,248) (13,741) (13,879) (4,054) Source: FactSet, Daiwa forecasts

- 61 - China Railway Sector 9 January 2015

 Balance sheet (CNYm) As at 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016E Cash & short-term investment 55,070 55,923 74,168 82,346 79,783 69,006 52,921 39,692 Inventory 19,138 26,615 30,095 33,187 40,799 46,845 50,903 54,212 Accounts receivable 96,917 110,136 139,109 74,012 91,264 104,788 123,213 131,225 Other current assets 67,783 99,321 116,952 226,742 259,215 318,240 355,519 387,968 Total current assets 238,909 291,996 360,324 416,287 471,061 538,879 582,556 613,097 Fixed assets 30,441 37,364 40,572 40,271 43,164 47,401 51,238 55,457 Goodwill & intangibles 5,788 6,373 6,791 8,304 10,731 13,114 15,496 17,879 Other non-current assets 7,853 14,532 15,296 15,800 28,062 29,890 31,622 32,834 Total assets 282,990 350,265 422,983 480,661 553,019 629,283 680,912 719,267 Short-term debt 12,586 17,428 55,626 72,820 68,813 60,500 57,664 57,664 Accounts payable 121,894 158,660 174,437 180,876 200,616 230,788 251,048 267,698 Other current liabilities 73,116 86,722 88,678 115,116 121,477 144,357 156,090 164,283 Total current liabilities 207,595 262,809 318,742 368,812 390,906 435,644 464,801 489,645 Long-term debt 13,565 22,415 30,611 31,390 71,685 91,685 91,685 91,685 Other non-current liabilities 7,751 6,810 7,911 7,130 6,603 6,688 7,232 7,611 Total liabilities 228,911 292,034 357,264 407,332 469,194 534,018 563,718 588,942 Share capital 12,338 12,338 12,338 12,338 12,338 12,338 13,718 13,718 Reserves/R.E./others 40,928 45,066 52,411 59,626 68,649 78,581 97,610 109,214 Shareholders' equity 53,265 57,403 64,748 71,964 80,987 90,919 111,328 122,932 Minority interests 814 828 970 1,366 2,838 4,347 5,867 7,393 Total equity & liabilities 282,990 350,265 422,983 480,661 553,019 629,283 680,912 719,267 EV 64,901 76,724 104,764 113,773 154,046 178,070 192,838 207,594 Net debt/(cash) (28,919) (16,080) 12,070 21,864 60,715 83,179 96,428 109,657 BVPS (CNY) 4.317 4.653 5.248 5.833 6.564 7.369 8.116 8.962

 Key ratios (%) Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016E Sales (YoY) 57.2 32.2 (2.8) 6.0 21.3 9.2 8.0 5.2 EBITDA (YoY) 50.2 (5.2) 49.9 12.4 9.8 16.9 10.9 11.0 Operating profit (YoY) 48.8 (25.8) 86.4 19.6 15.0 22.6 9.8 10.0 Net profit (YoY) 30.8 13.7 11.7 9.1 22.0 11.5 6.8 10.2 Core EPS (fully-diluted) (YoY) 30.8 13.7 11.7 9.1 22.0 11.5 (4.0) 10.2 Gross-profit margin 6.5 6.0 7.7 7.9 7.5 7.2 7.1 7.0 EBITDA margin 4.3 3.1 4.8 5.1 4.6 4.9 5.1 5.3 Operating-profit margin 2.5 1.4 2.7 3.0 2.9 3.2 3.3 3.4 Net profit margin 1.8 1.5 1.8 1.8 1.8 1.9 1.8 1.9 ROAE 12.1 12.6 12.7 12.4 13.5 13.4 12.2 11.6 ROAA 2.4 2.2 2.0 1.9 2.0 2.0 1.9 1.9 ROCE 11.4 7.1 9.5 8.6 8.1 8.5 8.5 8.8 ROIC 30.2 13.4 15.5 12.8 10.9 9.7 8.8 8.3 Net debt to equity n.a. n.a. 18.6 30.4 75.0 91.5 86.6 89.2 Effective tax rate 19.0 29.1 21.6 21.8 19.9 21.5 21.5 21.5 Accounts receivable (days) 87.8 82.8 102.6 82.8 52.9 57.5 61.9 65.7 Current ratio (x) 1.2 1.1 1.1 1.1 1.2 1.2 1.3 1.3 Net interest cover (x) 12.7 8.4 5.7 4.3 4.3 3.8 3.5 3.5 Net dividend payout 29.9 29.1 15.7 16.0 15.5 16.0 16.0 16.0 Free cash flow yield 5.0 n.a. n.a. n.a. n.a. n.a. n.a. n.a. Source: FactSet, Daiwa forecasts

 Company profile China Railway Construction is one of the duopolies in China’s railway construction market, enjoying about a 40-45% market share in China. The company also engages in design, survey and construction of other infrastructure assets, such as roads, urban rapid transit systems, water conservancy, and hydropower facilities construction. Moreover, it has manufacturing, property development and toll road operation businesses and a mining business.

- 62 - China Railway Sector 9 January 2015

Sufficient backlog to support growth into 2015-16

By the end of November 2014, the NDRC had approved Immediate beneficiary a total of 64 new railway construction projects, most of which were approved between the end of October and of China’s railway FAI the end of November 2014. boom We estimate that the value of CRCC’s new contracts received will increase by an average of 5% YoY each year over 2014-16, backed by strong growth in CRCC is one of the duopolies in China’s investment for HSR and urban rail transit systems. In railway construction market, enjoying our view, CRCC’s current new contract and backlog coverage is sufficient to support its strong net profit about a 40-45% market share. It stands growth into 2015 and 2016. to benefit handsomely from China’s rising investment in railway infrastructure in  CRCC: new contracts 2015-16. (CNYm) 1,200,000 18% 16% 1,000,000 14% One of duopolies in railway 800,000 12% 10% construction 600,000 8% 400,000 6% As one of the duopolies in China’s railway construction 4% 200,000 market, CRCC should be an immediate beneficiary of 2% the China government’s positive railway infrastructure 0 0% FAI upcycle. Historically, about 40% of the company’s 2012 2013 2014E 2015E 2016E construction revenue has come from railway New contract value YoY % construction. As such, railway infrastructure FAI is Source: Company, Daiwa closely correlated to CRCC’s railway construction revenue.  CRCC: backlog (CNYm) We believe the upcoming 13th Five Year Plan (FYP) for 3,000,000 30% railway, due to be announced in 3Q15, will support the 2,500,000 25% long-term stable growth of the nation’s railway build- out and protect the downside for its economic growth. 2,000,000 20% 1,500,000 15%  Historical FYP FAI: targets versus actual spending 1,000,000 10%

(CNY mn) 500,000 5% 4,000 0 0% 3,500 2012 2013 2014E 2015E 2016E 3,000 Backlog value YoY % 2,500 Source: Company, Daiwa 2,000 1,500 1,000 500 0 10th FYP 11th FYP 12th FYP Railway FAI - Original Target Railway FAI - Actual/Expected Investment

Source: CRC, Daiwa

- 63 - China Railway Sector 9 January 2015

Robust overseas growth Share placement to fund BT/BOT projects In our opinion, the competitiveness of China’s railway constructors is noticeable in overseas markets. For CRCC announced on 16 December 2014 the non-public example, we estimate that the cost to construct China’s issuance of A shares to fund 4 BT/BOT projects and to HSR was about two-thirds on average of the total cost repay bank loans. Details of the issuance are as follows: in other overseas countries. With the ongoing news 1) not more than 1,380m A shares, 2) to not more than flow relating to China’s favourable policies to facilitate 10 target investors, 3) placement price not less than the export of railway capacity, we expect investment CNY7.2 per share, and 4) 12-month lock-up period. sentiment to remain strong on this sector this year. If we assume full placement of the 1,380m shares at At the end of 1H14, CRCC’s overseas new contracts had CNY7.2 per share, CRCC would raise a total of increased by 410% YoY and accounted for 25% of its CNY9,936m, representing an 11% share capital total new contract value. As such, its overseas revenue enlargement. Under this scenario, net gearing would rose by 33% YoY for 1H14, versus a rise of 22% YoY for drop to 87% in 2015E from 91% in 2014E. We expect the whole of 2013. We expect CRCC’s revenue from around 9% EPS dilution on the full placement of the overseas markets to continue to accelerate (at a CAGR shares. of 59% for 2014-16E) along with robust growth in new contracts.  CRCC: use of proceeds from share placement Type Project Name Investment (CNYm)  CRCC: overseas contract growth BT Chongqing Rail Transit Construction (Phase II) 2,500 (CNYm) Xiaohuilou to New Shijiazhuang section of Phase I (Rail 250,000 140% BT Transit Line 3 in Shijiazhuang) 1,800 BT Chengdu Subway Line 10 Construction 1,600 120% 200,000 BOT Xiajing-Liaocheng section of Dezhou-Shangqiu Expressway 1,200 100% Repayment of bank borrowings and replenishment of liquidity 2,836 150,000 80% Total 9,936 60% Source: Company, Daiwa 100,000 40% 20% 50,000 Operations and financials 0% 0 (20%) 2012 2013 2014E 2015E 2016E CRCC is one of China’s leading construction companies New contract - overseas YoY growth that focuses on infrastructure construction for Source: Company, Daiwa railways, roads, urban rapid transit systems, and water conservancy projects, etc. We estimate that the  CRCC: overseas revenue growth construction business contributed 80% of total revenue

(CNYm) and 69% of EBIT in 2014, backed by the railway 80,000 80% investment up-cycle, margin improvement and solid 70,000 70% order growth for the overseas construction business. 60,000 60% 50,000 50% Business segments 40,000 40% We forecast revenue from railway construction to 30,000 30% rise by 15% YoY for 2014, 15% YoY for 2015 and 10% 20,000 20% YoY for 2016 on the back of the railway FAI upcycle. 10,000 10% However, we expect road construction revenue to see a 0 0% negative CAGR of 2.5% for 2014-16, due to high local- 2012 2013 2014E 2015E 2016E government debt levels and therefore possible funding Revenue - overseas YoY growth issues. Source: Company, Daiwa CRCC also provides construction surveying, design and consultancy services to government and state-owned business jointly and separately via its construction business. We estimate this business contributed 1.0% of revenue but 3% of EBIT for 2014. On our forecasts, over 80% of the revenue from the

- 64 - China Railway Sector 9 January 2015

survey, design and consultancy business segment is for Core earnings railway construction projects. In terms of company-wide earnings, we forecast CRCC to record 12% YoY core earnings growth for 2014, 7% The manufacturing business mainly engages in YoY for 2015 and 10% YoY for 2016, backed by strong large track maintenance machinery manufacturing construction revenue growth, although a weakening through its subsidiary, Kunming China Railway Large earnings contribution from its property business Maintenance Machinery (KCRC) in Kunming (Yunnan should also have an impact on the bottom line. Province in the southwest of China). We expect However, we forecast EPS for 2015 to decline by 4% earnings growth for the manufacturing business to YoY due to dilution from the new share placement. We accelerate over 2014-16, as it benefits from the upcycle see upside risk to our property assumption, should of railway investment and railway systems upgrades. there be any policy-easing measures affecting China’s As such, we forecast revenue from this business to see a property sector in 2015. decent 15% CAGR for 2014-16. We estimate that the manufacturing business contributed 2% of CRCC’s Gearing revenue and 3% of its EBIT for 2014. We estimate CRCC to record high net gearing of 91% in 2014, but expect it to decrease to 87% in 2015 and rise The company’s property business accounted for slightly to 89% in 2016, after the CNY9.9bn share about 4% of revenue and 10% of EBIT for 2014, on our placement and higher earnings contributions from estimates. We forecast CRCC to post property revenue railway construction. We forecast ROE to retreat to declines of 20% YoY for 2015 and 10% YoY for 2016 as 12.2% in 2015 and 11.6% in 2016, from 13.4% in 2014, a result of the slowdown in China’s property sector. as the share placement is expected to be settled in 2015. At current share-price levels, CRCC offers  CRCC: EBIT contribution dividend yields of 1.8% for 2015E and 2.0% for 2016E.

100% Working capital 17% 14% 90% 19% 21% 25% In our view, despite its high gearing but improving 3% 2% balance sheet, CRCC will have sufficient working 80% 3% 3% 2% 2% 4% 3% capital for construction projects as long as it does not 3% 70% 3% aggressively involve itself in BT/BOT projects in the 81% future. 74% 75% 77% 60% 69% With China’s setting up of the Railway Development 50% Fund in September 2014 to attract private investment 2012 2013 2014E 2015E 2016E to the railway sector, we believe funding for the Construction Survey & Design Manufacturing Others & Eliminations increasing railway FAI is not a concern for CRC. Source: Company, Daiwa According to the fund’s guidelines, the fund serves as a market entity for railway investment and financing.  CRCC: revenue contribution China’s national railway operator, China Railway 100% Corporation (CRC) (and the fund’s major backer), 12% 15% 14% represents government investments and is responsible 90% 17% 16% 2% for the daily management of the fund. 2% 2% 2% 2% 2% 1% 1% 80% 1% 1%

70% 84% 80% 80% 82% 83% 60%

50% 2012 2013 2014E 2015E 2016E Construction Survey & Design Manufacturing Others & Eliminations

Source: Company, Daiwa

- 65 - China Railway Sector 9 January 2015

 CRCC: key assumptions (In CNYm except otherwise indicated) 2012 2013 2014E 2015E 2016E Risks to our call Construction business revenue 407,601 468,015 515,759 567,715 602,218 YoY growth 0.0% 14.8% 10.2% 10.1% 6.1% The main risk to our call would be regulatory risk, as Gross margin 9.7% 9.7% 9.4% 9.7% 9.7% EBIT margin 5.3% 5.5% 5.3% 5.9% 6.2% CRCC’s revenue relies highly on China’s railway FAI New contract value 660,343 690,705 724,427 755,291 788,960 target. Any unfavourable changes in the country’s YoY growth 12.4% 4.6% 4.9% 4.3% 4.5% railway policy would likely have a severe impact on Backlog 1,380,637 1,601,626 1,810,294 1,997,870 2,184,611 CRCC. YoY growth 22.4% 16.0% 13.0% 10.4% 9.3% Survey & Design revenue 7,287 7,761 8,538 8,964 9,413 YoY growth -2.4% 6.5% 10.0% 5.0% 5.0% A secondary consideration would be political risks as Gross margin 30.6% 28.7% 32.0% 32.0% 32.0% CRCC expands overseas, especially in those new EBIT margin 14.1% 11.5% 11.7% 11.7% 11.7% markets where it has less experience (also because New contracts 8,181 9,192 9,652 10,135 10,641 overseas legal and regulatory requirements differ from YoY growth 7.8% 12.4% 5.0% 5.0% 5.0% Backlog 2,748 4,179 5,293 6,463 7,692 those in China). YoY growth 48.3% 52.1% 26.7% 22.1% 19.0% Manufacturing revenue 9,984 11,756 12,931 14,224 14,936 YoY growth 12.0% 17.7% 10.0% 10.0% 5.0% Gross margin 18.6% 17.4% 20.0% 20.0% 20.0% EBIT margin 7.7% 6.4% 9.9% 10.1% 10.1% New contracts 10,281 12,019 14,423 16,586 17,415 YoY growth -14.1% 16.9% 20.0% 15.0% 5.0% Backlog 2,986 3,249 4,741 7,102 9,582 YoY growth 11.0% 8.8% 45.9% 49.8% 34.9% Other operations revenue 70,855 114,040 121,104 119,803 120,779 YoY growth 52.5% 60.9% 6.2% -1.1% 0.8% Property development business 18,137 24,710 27,181 21,744 19,570 YoY growth 34.0% 36.2% 10.0% -20.0% -10.0% Logistics & others 52,718 89,330 92,904 96,620 99,518 YoY growth 60.1% 69.4% 4.0% 4.0% 3.0% Mining - - 1,020 1,439 1,690 YoY growth n.m. n.m. n.m. 41.1% 17.5% Gross margin 10.9% 8.5% 9.3% 7.1% 6.4% Real estate development 27.9% 25.6% 25.6% 18.0% 15.0% Logistics 5.1% 3.8% 4.0% 4.0% 4.0% Others 0.0% 0.0% 54.8% 51.9% 45.5% EBIT margin 7.9% 6.2% 8.3% 6.1% 5.3% Eliminations (11,415) (14,782) (16,177) (17,464) (18,365) Source: Company, Daiwa forecasts

Valuation and recommendation

We initiate coverage of CRCC with a Buy (1) rating and 12-month target price of HKD11.70 based on a 9.5x PER on our 2016 EPS forecast, largely in line with the stock’s past-5-year average. Our target price implies a 2015E PER of 10.5x.

In our view, CRCC’s fundamentals are strong because of: 1) its duopoly position in China’s railway construction market, with it standing to benefit from China’s railway infrastructure FAI upcycle, 2) the acceleration in domestic railway new orders after CRC raised the target three times in 2014, and 3) robust order growth in overseas markets supported by favourable government policies that support railway construction, as seen in new contract growth and high backlog coverage.

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 CRCC: valuation Valuation 2016E Earnings (pre-exceptional) 13,576 PER (x) 9.5 PER (x) Equity value (CNYm) 128,972 6.5 7.5 8.5 9.5 10.5 11.5 12.5 Exchange rate, HKD:CNY 0.80 0.82 7.8 9.0 10.2 11.4 12.6 13.8 15.0 Equity value (HKDm) 161,213 0.81 7.9 9.1 10.3 11.6 12.8 14.0 15.2 13,718 8.0 9.2 10.5 11.7 12.9 14.2 15.4

Number of shares (m) FX 0.80 Equity value/share (HKD) 11.7 0.79 8.1 9.3 10.6 11.9 13.1 14.4 15.6 Share price (HK$) 9.73 0.78 8.2 9.5 10.7 12.0 13.3 14.5 15.8 Potential upside/downside (%) 20.2%

Implied 2015E Target PER 10.5 Source: Daiwa; based on 7 Jan closing price

 CRCC: one-year forward PER bands  CRCC: one-year forward PBR bands

Historical Avg PER: 11.3x (HKD) (HKD) Historical Avg PB: 1.3x 22x 18x 16 14x 2.9x 16 2.4x 1.9x 14 1.4x 14 12 10x 12 10 10 0.9x 8 8 6 6x 6 4 4 0.4x 2 2x 2 0 0 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Sep-09 Sep-10 Sep-11 Sep-12 Sep-13 Sep-14 May-09 May-10 May-11 May-12 May-13 May-14 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Sep-09 Sep-10 Sep-11 Sep-12 Sep-13 Sep-14 May-09 May-10 May-11 May-12 May-13 May-14 Source: Company, Daiwa forecasts Source: Company, Daiwa forecasts

- 67 - China Railway Sector 9 January 2015

 CRCC: revenue contribution (2013) Company background Others & Eliminations 16.9% CRCC is one of the duopolies in China’s railway construction market (the other being CRG), with a Manufacturing 2.0% market share in China of about 40-45%. The company Survey & is engaged in the design, survey and construction of Design railways, road, urban rapid transit systems, water 1.3% conservancy, and hydropower facility construction.

Overall construction revenue contributed 80% of its Construction total revenue and 75% of its total EBIT in 2013. 79.8% Revenue from railway construction accounted for 35% of the company’s total revenue in 2013. Most of the Source: Company construction contracts are fixed-price contracts under which the company is responsible for procuring raw  CRCC: EBIT contribution (2013) materials, including steel and cement, which therefore Others & exposes it to rising commodity price risk. Eliminations 20.7%

In view of the higher margins in other non- construction segments, and in an effort to mitigate the Manufacturing company’s reliance on the China government’s railway 2.2% Survey & FAI policies, management has diversified its business Design into other non-construction segments including 2.6% property development. At the end of 1H14, CRCC had a landbank of 34.6m sqm in China. The property Construction business accounted for 2.5% of total revenue and 9% of 74.5% total gross profit in 1H14. Source: Company CRCC was ranked No. 2 globally in 2013 by Engineering News-Record in terms of construction contracting revenue. CRCC’s parent, China Railway Construction Corp, has a 61% stake in CRCC.

- 68 -

Industrials / China 1800 HK Industrials / China 9 January 2015

China Communications Construction

China Communications Construction Target (HKD): 9.30 Downside: 3.7% 1800 HK 7 Jan price (HKD): 9.66

Initiation: positives priced in 1 Buy • Stands to benefit from “One belt one road”, albeit this could take 2 Outperform several years to materialise and looks priced in for now 3 Hold (initiation) • We foresee slower growth in the China infrastructure projects 4 Underperform that CCC is engaged in given local government funding issues 5 Sell • Initiating with a Hold (3) rating and 12-month target price of HKD9.30, based on a 8x PER on core 2016E EPS •

How do we justify our view?

Due to CCC’s continuing ■ Risks investments in BT/BOT projects, we Key risks to our view are: local forecast its capex to rise by 50% YoY government funding issues, as well to CNY38bn for 2014, above as lower or higher profit margins management’s original plan of and lower or higher interest Brian Lam CNY28bn; and we still see further expenses vs. our expectations. (852) 2532 4341 upside to these capex forecasts. [email protected] For 9M14, CCC registered 6.6% YoY Kelvin Lau new contract growth, mainly driven (852) 2848 4467 by overseas construction projects, [email protected] due to a recovery in the overseas Share price performance construction market, but offset by a (HKD) (%) 10 165 ■ Investment case slowdown in government investment in road & bridge 9 144 CCC is a leading player in the 7 123 construction, BT/BOT projects and construction of ports and roads in 6 101 dredging works. China, with such projects funded 4 80 Jan-14 Apr-14 Jul-14 Oct-14 Jan-15 largely by local governments. It is ■ Catalysts Ch Com Con (LHS) Relative to HSI (RHS) also active in overseas construction From a macro perspective, an projects, including dredging and interest-rate cut in China could port machinery. provide upside potential to our target 12-month range 4.97-10.00 Market cap (USDbn) 20.15 We believe CCC is well placed to price and earnings forecasts for CCC 3m avg daily turnover (USDm) 47.09 benefit from China’s proposed “One as it could see interest expense savings Shares outstanding (m) 16,175 Major shareholder CCCG (63.8%) belt one road” concept (ie, the given CCC’s high net gearing of 128% construction of infrastructure for end-2014E. Financial summary (CNY) projects overseas), but expect this to We see few fundamental near-term Year to 31 Dec 14E 15E 16E materialise only in the long term. stock catalysts in view of our below- Revenue (m) 358,556 391,662 387,170 Operating profit (m) 22,371 25,889 28,090 Meanwhile, we see funding pressure consensus 2014-16E EPS, which build going forward for the domestic Net profit (m) 12,899 14,144 15,067 in slower growth assumptions for local Core EPS (fully-diluted) 0.797 0.874 0.932 construction projects it is engaged government-funded projects and EPS change (%) 4.1 9.7 6.5 in, given the local governments’ high rising interest expenses. Daiwa vs Cons. EPS (%) (4.7) (3.5) (6.1) debt levels (CCC’s domestic ports PER (x) 9.7 8.8 8.3 and roads construction revenue ■ Valuation Dividend yield (%) 2.7 2.7 2.9 accounted for 44% of its total 1H14 DPS 0.207 0.211 0.225 Our 12-month target price is PBR (x) 1.2 1.1 1.0 revenue). Thus, we initiate coverage HKD9.30, based on a target 8x PER EV/EBITDA (x) 8.4 8.2 8.2 with a Hold (3) rating. (the past-5-year average) applied to ROE (%) 12.9 12.7 12.3 our core 2016E EPS. Source: FactSet, Daiwa forecasts

See important disclosures, including any required research certifications, beginning on page 80 China Railway Sector 9 January 2015

1 Buy How do we justify our view? 2 Outperform

3 Hold (initiation)  Growth outlook

4 Underperform  Valuation 5 Sell  Earnings revisions

 Growth outlook  CCC: reported-basis net profit and net profit growth (2010-16E) We forecast the company to post recurring net profit (CNYm) growth of 4% YoY for 2014 (up 10% YoY on a reported 16,000 35% basis given a one-off disposal gain), 10% for 2015E and 14,000 30% 7% for 2016E. We expect this growth to be driven 12,000 25% 10,000 mainly by new orders from overseas markets, offset in 20% part by slower growth in the government’s investment 8,000 15% in domestic infrastructure projects (including roads and 6,000 bridges, BOT projects and dredging works) due to 4,000 10% funding constraints by local governments for such 2,000 5% projects. 0 0% 2010 2011 2012 2013 2014E 2015E 2016E Net Profit (LHS) Growth (YoY, RHS) Source: Company, Daiwa forecasts

 Valuation  CCC: 12-month forward PER (x) Based on our core EPS forecasts, CCC is trading at PERs (PER) of 8.8x for 2015E and 8.3x for 2016E, above its past-5- 20 year average trading PER of 8x. Our 12-month target 18 16 price of HKD9.30 is based on a PER of 8x (in line with 14 +1 SD the past-5-year average) applied to our core 2016E EPS 12 10 (calculated from our recurring net profit forecast). Our Avg target price implies a PER of 8.5x PER on our core 8 6 -1 SD 2015E EPS, in line with CCC’s past-5-year average 4 trading PER. 2

Jul-09 Jul-10 Jul-11 Jul-12 Jul-13 Jul-14 Apr-09 Oct-09 Apr-10 Oct-10 Apr-11 Oct-11 Apr-12 Oct-12 Apr-13 Oct-13 Apr-14 Oct-14 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Trading PE Average +1 SD -1 SD

Source: Bloomberg

 Earnings revisions  CCC: revisions to consensus 2015-16 EPS forecasts Since early 2014, the Bloomberg consensus 2015-16E EPS (CNY) for CCC have been revised down by 8%, driven we 1.06 believe by the consensus becoming slightly more 1.01 conservative on CCC’s earnings. 0.96 0.91 Our core EPS forecasts for 2014-16E are 4-6% are below consensus, as we assume slower growth in the 0.86 company’s local government-funded projects and rising 0.81 interest expenses over our forecast period. 0.76 0.71 Jan-14 Mar-14 May-14 Jul-14 Sep-14 Nov-14 2015E 2016E Source: Bloomberg

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 Key assumptions Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016E New contracts (CNYm) 360,363 411,738 457,848 514,920 543,261 614,431 683,068 728,159 New contracts % 27.3 14.3 11.2 12.5 5.5 13.1 11.2 6.6 Backlog (CNYm) 426,027 512,103 601,912 700,525 738,055 980,930 1,259,336 1,587,326 Backlog % 27.4 20.2 17.5 16.4 5.4 32.9 28.4 26.0

 Profit and loss (CNYm) Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016E Construction 165,563 212,962 227,068 229,401 264,146 293,211 324,151 315,237 Port Machinery 27,070 17,221 20,166 19,317 24,171 26,174 28,325 30,669 Other Revenue 34,287 42,551 47,047 46,603 43,481 39,171 39,186 41,263 Total Revenue 226,920 272,734 294,281 295,321 331,798 358,556 391,662 387,170 Other income 843 1,145 1,638 1,271 1,927 1,558 1,669 1,709 COGS (205,215) (249,261) (266,374) (262,723) (297,860) (320,996) (349,647) (343,005) SG&A (10,164) (10,685) (13,557) (14,644) (16,290) (16,747) (17,795) (17,784) Other op.expenses 0 0 0 00000 Operating profit 12,384 13,933 15,988 19,225 19,575 22,371 25,889 28,090 Net-interest inc./(exp.) (2,313) (1,788) (2,292) (3,784) (3,945) (6,028) (7,939) (8,948) Assoc/forex/extraord./others 243 308 1,333 110 222 1,556 300 300 Pre-tax profit 10,314 12,453 15,029 15,551 15,852 17,900 18,250 19,441 Tax (2,310) (2,552) (3,046) (3,790) (3,580) (4,027) (4,106) (4,374) Min. int./pref. div./others (804) (38) (216) 516 296 0 0 0 Net profit (reported) 7,200 9,863 11,767 12,277 12,568 13,872 14,144 15,067 Net profit (adjusted) 6,966 8,976 10,704 12,194 12,396 12,899 14,144 15,067 EPS (reported)(CNY) 0.486 0.665 0.794 0.771 0.777 0.858 0.874 0.932 EPS (adjusted)(CNY) 0.470 0.605 0.722 0.766 0.766 0.797 0.874 0.932 EPS (adjusted fully-diluted)(CNY) 0.470 0.605 0.722 0.766 0.766 0.797 0.874 0.932 DPS (CNY) 0.116 0.160 0.196 0.188 0.188 0.207 0.211 0.225 EBIT 12,384 13,933 15,988 19,225 19,575 22,371 25,889 28,090 EBITDA 16,928 19,384 22,480 26,212 27,617 31,333 35,899 39,122

 Cash flow (CNYm) Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016E Profit before tax 10,314 12,453 15,029 15,551 15,852 17,900 18,250 19,441 Depreciation and amortisation 4,544 5,451 6,492 6,987 8,042 8,961 10,010 11,032 Tax paid (2,417) (2,289) (2,604) (3,219) (3,677) (4,027) (4,106) (4,374) Change in working capital 2,479 61 (16,771) (9,705) (16,275) (18,431) (15,297) (15,168) Other operational CF items (313) (3,147) (608) 3,726 2,817 5,289 (7,409) (2,088) Cash flow from operations 14,607 12,529 1,538 13,340 6,759 9,692 1,448 8,843 Capex (18,184) (14,403) (16,108) (19,286) (25,134) (38,000) (33,500) (32,743) Net (acquisitions)/disposals 568 (485) 785 (61) (2,207) (1,000) 0 0 Other investing CF items 726 (488) 937 (157) (745) 2,123 1,931 2,491 Cash flow from investing (16,890) (15,376) (14,386) (19,504) (28,086) (36,877) (31,569) (30,253) Change in debt 11,360 9,590 21,489 26,951 37,167 40,165 20,205 9,953 Net share issues/(repurchases) 60 111 165 5,008 474 0 0 0 Dividends paid (1,453) (1,720) (2,372) (2,902) (2,988) (3,035) (3,350) (3,416) Other financing CF items (145) (125) (139) (95) (91) 958 831 772 Cash flow from financing 9,822 7,856 19,143 28,962 34,562 38,088 17,685 7,309 Forex effect/others 00000000 Change in cash 7,539 5,009 6,295 22,798 13,235 10,903 (12,436) (14,100) Free cash flow (3,577) (1,874) (14,570) (5,946) (18,375) (28,308) (32,052) (23,900) Source: FactSet, Daiwa forecasts

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 Balance sheet (CNYm) As at 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016E Cash & short-term investment 33,817 38,826 45,121 67,503 81,238 92,141 79,705 65,605 Inventory 18,835 21,473 22,603 27,113 32,850 44,873 48,764 58,412 Accounts receivable 111,001 129,882 154,527 169,825 196,001 227,442 259,212 272,030 Other current assets 814 834 1,033 7,167 8,764 9,471 10,345 10,227 Total current assets 164,467 191,015 223,284 271,608 318,853 373,927 398,027 406,273 Fixed assets 47,351 52,438 55,148 56,812 55,619 56,283 54,577 54,256 Goodwill & intangibles 13,764 20,489 32,010 44,480 62,865 91,240 116,436 138,468 Other non-current assets 38,476 43,852 48,338 61,377 80,108 72,988 77,592 77,308 Total assets 264,058 307,794 358,780 434,277 517,445 594,438 646,632 676,305 Short-term debt 36,043 42,760 54,289 69,187 87,818 107,818 107,818 107,818 Accounts payable 117,584 145,829 146,777 165,972 198,064 218,653 236,950 244,726 Other current liabilities 2,057 2,527 17,903 19,027 18,853 23,297 25,364 24,885 Total current liabilities 155,684 191,116 218,969 254,186 304,735 349,768 370,132 377,429 Long-term debt 34,694 38,569 51,756 75,058 99,157 119,157 139,157 149,157 Other non-current liabilities 7,451 7,029 7,110 8,920 8,712 8,877 9,082 9,034 Total liabilities 197,829 236,714 277,835 338,164 412,604 477,802 518,371 535,621 Share capital 52,894 57,770 67,304 83,671 91,826 91,826 91,826 91,826 Reserves/R.E./others 1,720 2,372 2,902 2,988 3,035 13,872 24,666 36,318 Shareholders' equity 54,614 60,142 70,206 86,659 94,861 105,698 116,492 128,144 Minority interests 11,615 10,938 10,739 9,454 9,980 10,938 11,769 12,541 Total equity & liabilities 264,058 307,794 358,780 434,277 517,445 594,438 646,632 676,305 EV 170,297 174,928 192,740 206,503 233,088 261,843 294,810 319,382 Net debt/(cash) 36,920 42,503 60,924 76,742 105,737 134,834 167,270 191,370 BVPS (CNY) 3.684 4.057 4.736 5.358 5.865 6.535 7.202 7.922

 Key ratios (%) Year to 31 Dec 2009 2010 2011 2012 2013 2014E 2015E 2016E Sales (YoY) 26.8 20.2 7.9 0.4 12.4 8.1 9.2 (1.1) EBITDA (YoY) 10.9 14.5 16.0 16.6 5.4 13.5 14.6 9.0 Operating profit (YoY) 5.2 12.5 14.7 20.2 1.8 14.3 15.7 8.5 Net profit (YoY) 54.9 28.9 19.2 13.9 1.7 4.1 9.7 6.5 Core EPS (fully-diluted) (YoY) 54.9 28.9 19.2 6.1 0.0 4.1 9.7 6.5 Gross-profit margin 9.6 8.6 9.5 11.0 10.2 10.5 10.7 11.4 EBITDA margin 7.5 7.1 7.6 8.9 8.3 8.7 9.2 10.1 Operating-profit margin 5.5 5.1 5.4 6.5 5.9 6.2 6.6 7.3 Net profit margin 3.1 3.3 3.6 4.1 3.7 3.6 3.6 3.9 ROAE 14.5 15.6 16.4 15.5 13.7 12.9 12.7 12.3 ROAA 2.9 3.1 3.2 3.1 2.6 2.3 2.3 2.3 ROCE 10.0 9.6 9.4 9.0 7.4 7.0 7.2 7.3 ROIC 10.3 10.2 10.0 9.2 7.9 7.5 7.3 6.9 Net debt to equity 67.6 70.7 86.8 88.6 111.5 127.6 143.6 149.3 Effective tax rate 22.4 20.5 20.3 24.4 22.6 22.5 22.5 22.5 Accounts receivable (days) 171.7 161.2 176.4 200.4 201.2 215.5 226.8 250.4 Current ratio (x) 1.1 1.0 1.0 1.1 1.0 1.1 1.1 1.1 Net interest cover (x) 5.4 7.8 7.0 5.1 5.0 3.7 3.3 3.1 Net dividend payout 23.9 24.0 24.7 24.3 24.1 24.1 24.1 24.1 Free cash flow yield n.a. n.a. n.a. n.a. n.a. n.a. n.a. n.a. Source: FactSet, Daiwa forecasts

 Company profile Listed on the stock exchanges of Hong Kong in 2006 and Shanghai in 2012, CCC is a state owned enterprise under the SASAC. It is principally engaged in the construction and design of transportation infrastructure, dredging and port machinery manufacturing. CCC is the largest port construction company and the largest dredging company in China, and is the third- largest dredging company worldwide. One of its subsidiaries, Zhenhua Heavy Machinery, is the world’s largest manufacturer of container cranes. CCC’s parent company is China Communications Construction Group, with a 63.8% shareholding.

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We note China’s YTD FAI growth in municipal projects had moderated to 16.2% YoY by the end of November 2014, from a 35% high in September 2009.

 China FAI: municipal projects (YTD) YoY growth (%) A leading 35 infrastructure 30 constructor in China 25

As a major infrastructure player in 20 China, CCC looks set to benefit from overseas market growth through the 15 country’s “one belt one road” policy, 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014E 2015E Source: CEIC, Daiwa though we believe this may take several years to materialise. Near term we expect  China: local governments’ total outstanding debt (year-end) slowing growth in CCC’s domestic (CNYbn) infrastructure projects given funding 20,000 70% issues by local governments. 60% 15,000 50% 40% 10,000 A dominant player in local 30% government-funded projects 5,000 20% 10% CCC is the largest port construction company in China 0 0% and also the leading player in the construction of roads 2008 2009 2010 2011 2012 2013 and bridges. Some of the key projects constructed by Local government debt oustanding YoY Growth % CCC over recent years, and for which construction is Source: CEIC, Daiwa under way at present, include the Hong Kong-Zhuhai- Macau Bridge currently under construction, and most of China’s coastal container and bulk ports, including High capex given BT and BOT those in Shanghai, Shenzhen, Qingdao, Ningbo, Tianjin project investments and Guangzhou, etc. CCC is also involved in railway construction in China, though this comprises a small Due to CCC’s continuing investments into BT and BOT part of its business. projects, which are capex-intensive, we forecast its capex for 2014E to amount to CNY38bn, higher than Unlike railway investments in China, for which funding management’s original plan for CNY28bn and up is undertaken by China Railway Corporation (which substantially from CNY25.1bn for 2013. We still see reports to the central government) and for which upside to our capex forecast. funding issues are thus not a concern, most construction projects for roads and ports are funded by For 1H14, the values of CCC’s new contracts for BOT, the local governments. Given local governments’ high BT and preliminary land development projects debt levels currently (as shown in the subsequent amounted to CNY19.8bn, CNY6.8bn and CNY4.0bn, chart), some road and port construction projects in the respectively, representing respective proportions of country face funding issues. Thus, over 2015-16 we 65%, 22% and 13% of the total value of its new expect slowing growth for CCC’s domestic road and contracts for the period. port construction business albeit this should be offset partly by solid growth in its overseas construction On its BOT projects, as at end-1H14 the company had a business. total contracted investment size of CNY168.2bn in BOT projects, of which CNY81.5bn had been spent and

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about CNY39.4bn worth of assets had been put into operation by end-1H14. Long-term beneficiary of “One belt one road” proposal For its BT projects, CCC had, as at end-1H14, a total contracted investment size of CNY99.0bn, of which In 2H14, China announced that it would contribute CNY60.6bn had been spent, construction on USD40bn to a Silk Road fund for infrastructure, CNY39.6bn worth of projects had entered into the industrial, and financial cooperation between China payback period. and neighbouring countries located along the Silk Road, in order to foster international trade. Called the “One For its primary land-development projects, CCC had, belt one road" concept, this refers to China’s Silk Road as at end-1H14, a total investment size of CNY103.6bn, Economic Belt and 21st Century Maritime Silk Road of which CNY24.0bn had been spent and a sale amount initiatives. of CNY2.9bn had been realised. We believe China’s aim with this is to export  CCC: major BT, BOT and primary development projects technology, ease excess production capacity, and Project name Investment (CNYm) Guizhou Daozhen - Weng'an Expressway - BOT 23,868 deepen economic and political relationships with its Foshan Rail Transit in Guangdong - BOT 19,800 neighbouring countries, as well as further-flung Jiangkou-Weng’an Highway in Guizhou - BOT 14,061 countries. Guizhou Yanhe - Dejiang Expressway BOT 9,399 Haikou Xingang Port - BT 8,920 We expect to see continuous news flow on the “One belt Guiyang-Qianxi Highway in Guizhou - BOT 8,419 Chongqing Zhongxian - Wanzhou Expressway - BOT 8,091 one road” policy during 2015, which could boost Land development project in Sanya, Hainan 6,742 investment sentiment on major infrastructure players Gaochun-Nanjing New Channel in Jiangsu - BT 5,919 like CCC, given that they stand to benefit from this Liaoning Jianchang - Xingcheng Expressway - BT 5,152 policy. The “one belt one road” policy may speed up Construction project of Baiyun New Town in Songzi, Hubei 4,000 Hainan Tunchang - Qiongzhong Expressway - BT 3,257 some of the progress of existing infrastructure projects Hengqin headquarters project in Zhuhai 3,000 in some countries, but we believe the benefits for CCC Phase II of Dongfeng Avenue rapid transformation in Wuhan, Hubei - BT 2,652 are likely to take several years to materialise given the Construction of Changde Economic Development Zone in Hunan - BT 2,086 complexities involved in construction projects overseas. Comprehensive improvement project of Taixing Tianxingzhou in Jiangsu 1,350 Harbin Industrial Zone Infrastructure - BT 1,017 Wuhan Donghu Hi-tech Zone Roads - BT 955 Zhenjiang Yangzhong Jingang Expressway - BT 750 Financials Nanjing Pukou Public Pipes - BT 524 Total 129,963 We forecast CCC to post revenue growth of 8% YoY to Source: Company, Daiwa CNY359bn for 2014, driven mainly by construction

As a result of elevated capex for 2014E, we forecast revenue growth in its railway, port and overseas business, offset in part by slowing revenue growth for CCC’s net gearing to be up to 128% at end-2014, from its domestic road and bridge, BOT and dredging 111% at end-2013. CCC plans to issue preference shares of a potential amount of up to CNY14.5bn this year so businesses (due to lower funding by local governments). We expect a similar revenue pattern by as to maintain its total liabilities/total assets ratio at business segment for 2015 and 2016. the 80% level set by China’s State-owned Assets Supervision and Administration Commission (SASAC). For 2014E, CCC will record a disposal gain of We currently forecast the company’s net gearing to decline to 144% for end-2015E, but estimate that this CNY1.3bn on the sale of its 2.93% stake in Taikang Life, a domestic insurance company in China. Factoring in level could drop by 15pp to 129% if we were to include this one-off disposal gain, we forecast 10% YoY growth preference share issuance at the maximum amount. in the company’s reported-basis net profit growth to CNY13,872m for 2014E. Excluding this gain, we We forecast CCC’s interest expense to be up forecast recurring net profit growth of 4% YoY for significantly for 2014E on the back of higher leverage resulting from its continuous investments in BT and 2014E, with high interest expenses likely weighing on the bottom line. BOT projects. We forecast interest expenses to rise from CNY6.4bn for 2013 to CNY8.9bn for 2014E, and increase further to CNY10.9bn for 2015E given the For end-2014, we forecast CCC to have a net gearing of company’s high gearing. 128% (as discussed earlier in this report). We forecast its ROE to be 12.9% for 2014, 12.7% for 2015 and 12.3% for 2016. Based on the latest share price, CCC offers

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dividend yields of 2.7% for 2014E and 2.7% for 2015E,  CCC: key assumptions for business segments representing about a 24% payout. (CNYm except otherwise indicated) 2012 2013 2014E 2015E 2016E Construction revenue 229,401 264,146 293,211 324,151 315,237 YoY growth 1.0% 15.1% 11.0% 10.6% -2.7% Within CCC’s construction segment, its new contract Gross margin 9.7% 8.7% 9.0% 9.4% 10.2% value for railway construction was up strongly by 601% EBIT margin 5.9% 5.1% 5.6% 6.0% 6.8% for 1H14, accounting for 8% of the total value of its new New contract value 423,055 450,551 522,406 589,850 630,552 construction contracts compared with only 1% for YoY growth 16.0% 6.5% 15.9% 12.9% 6.9% Backlog value 619,800 653,706 882,901 1,148,599 1,463,915 1H13. The company’ robust growth in railway new YoY growth 21.1% 5.5% 35.1% 30.1% 27.5% orders in 1H14 was on the back of China’s strong Design revenue 16,468 19,394 19,782 20,178 20,581 railway FAI, though we note that CCC is not among the YoY growth 9.7% 17.8% 2.0% 2.0% 2.0% major beneficiaries of high domestic railway FAI due to Gross margin 25.7% 23.9% 23.5% 23.5% 23.5% EBIT margin 14.4% 13.3% 13.1% 13.1% 13.1% its small business exposure to railway construction. New contract value 23,570 25,191 26,199 27,247 28,336 YoY growth 2.7% 6.9% 4.0% 4.0% 4.0% For 9M14, CCC registered 6.6% YoY new contract Backlog 34,000 35,545 41,962 49,031 56,786 growth by value in total, driven mainly by its overseas YoY growth 6.3% 4.5% 18.1% 16.8% 15.8% construction business – due to a recovery in overseas Dredging revenue 32,027 32,789 30,166 29,563 31,041 YoY growth -0.9% 2.4% -8.0% -2.0% 5.0% construction markets – but offset partially by a Gross margin 14.2% 13.8% 13.0% 13.0% 13.0% slowdown in new contract value growth for its EBIT margin 11.0% 11.0% 7.4% 9.2% 9.2% domestic road and bridge construction projects, BT New contract 38,648 39,336 31,469 29,895 31,390 and BOT projects and its dredging business. YoY growth 3.0% 1.8% -20.0% -5.0% 5.0% Backlog 28,880 29,760 31,063 31,396 31,745 YoY growth 3.3% 3.0% 4.4% 1.1% 1.1%  CCC: revenue breakdown by business segment Port machinery manufacturing revenue 19,317 24,171 26,174 28,325 30,669 100% 2% 1% 1% 1% 1% YoY growth -4.2% 25.1% 8.3% 8.2% 18.3% 7% 7% 6% 7% 8% Gross margin 5.0% 6.6% 9.6% 9.7% 9.8% 90% 8% 7% EBIT margin -0.6% 0.3% 4.8% 3.9% 4.0% 11% 10% 8% 5% New contract value 24,615 27,850 32,028 33,629 35,310 80% 5% 5% 5% 6% YoY growth -7.7% 13.1% 15.0% 5.0% 5.0% Backlog 16,255 19,026 24,879 30,183 34,824 70% YoY growth -41.5% 17.0% 30.8% 21.3% 15.4% Revenue from other operations 6,462 3,706 2,224 2,446 2,642 60% 80% 76% 77% 79% 79% YoY growth -3.0% -42.6% -40.0% 10.0% 8.0% Gross margin 9.0% 5.6% 4.0% 4.0% 4.0% 50% EBIT margin -1.4% -5.6% -5.8% -5.8% -5.8% New contract value 5,032 333 2,331 2,448 2,570 40% YoY growth -16.5% -93.4% 600.0% 5.0% 5.0% 2012 2013 2014E 2015E 2016E Backlog 1,590 18 125 127 55 Construction Design Dredging Port machinery Others & eliminations

YoY growth -27.1% -98.9% 596.7% 1.3% -56.5% Source: Company, Daiwa forecasts Source: Company, Daiwa forecasts

 CCC: EBIT breakdown by business segment 100% 6% 4% 4% Valuation and recommendation 18% 90% 19% 10% 11% 10% We have a 12-month target price for CCC of HKD9.30, 10% 80% 12% 10% 12% 13% based on a target PER of 8x applied to our core 2016E 70% EPS forecast. Our target PER is in line with CCC’s past- 5-year average trading PER of 8x. 60% 73% 75% 76% 70% 69% 50% Our target price implies 3.7% downside potential from CCC’s current share price and thus we initiate coverage 40% of CCC with a Hold (3) rating. Even though we expect 2012 2013 2014E 2015E 2016E to see continuous positive news flow on the sector, we Construction Design Dredging Port machinery Others & eliminations think the CCC’s valuation looks fair and that the Source: Company, Daiwa forecasts positives have already been priced in.

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 CCC: valuation model and sensitivity of target price to PER and HKD/CNY exchange rate variations (HKD)

2016E net profit (pre-exceptionals) 15,067.1 Target PER (x) 8.0 PER (x) Equity value (CNYm) 120,537 HKD/rate 5.0 6.0 7.0 8.0 9.0 10.0 11.0 Exchange rate, 1HKD x CNY 0.80 0.82 5.7 6.8 8.0 9.1 10.2 11.4 12.5 Equity value (HKDm) 150,671 0.81 5.8 6.9 8.1 9.2 10.4 11.5 12.7 Number of shares (m) 16,175 0.80 5.8 7.0 8.2 9.3 10.5 11.6 12.8 Equity value/share (HKD) 9.3 0.79 5.9 7.1 8.3 9.4 10.6 11.8 13.0 Current share price (HKD) 9.66 0.78 6.0 7.2 8.4 9.6 10.7 11.9 13.1 Upside/downside potential (%) -3.7% Implied 2015E PER at target price (x) 8.5 Source: Daiwa estimates and forecasts

 CCC: PER bands  CCC: PBR bands

(HK$) Historical 5 Year Avg: 8x (HK$) 15 14x 25 Historical Ave PB: 2.0x 3.0x 2.5x 12x 20 10x 2.0x 10 15 8x 1.5x 6x 10 1.0x 5 4x 5 0.5x

0 0 Jul-11 Jul-14 Jul-11 Jul-14 Apr-11 Oct-11 Apr-14 Oct-14 Jan-09 Jun-09 Jan-11 Jun-12 Jan-14 Mar-09 Feb-10 Mar-12 Feb-13 Sep-09 Dec-09 Aug-10 Nov-10 Dec-11 Sep-12 Nov-12 Aug-13 Nov-13 Apr-09 Apr-11 Oct-11 Apr-14 Oct-14 Jan-09 Jun-09 Jan-12 Jun-12 Jan-14 Jan-15 May-10 May-13 Mar-10 Feb-11 Mar-12 Mar-13 Sep-09 Dec-09 Aug-10 Nov-10 Sep-12 Dec-12 Aug-13 Nov-13 May-10 May-13 Source: Bloomberg Source: Bloomberg

Risks Company background

Upside risks CCC is one of the leading infrastructure construction The key upside risk to our investment thesis on CCC companies in China, mainly engaged in construction would be an interest rate cut in China, which would projects for ports, roads and bridges. CCC was ranked result in upside potential to our target price and No.4 globally by Engineering News Record (ENR) in earnings forecasts for CCC as it could result in interest terms of construction revenue for 2013, and was named expense savings (CCC has high net gearing). as one of the Fortune Global 500 companies for 6 consecutive years (2008-13). A secondary upside risk would be higher-than-expected margin expansion for overseas projects, which typically CCC is the largest constructor of coastal container ports have higher margins than domestic projects. in China, enjoying about an 80% market share in terms of revenue. In addition to the construction of ports, Downside risks roads and bridges in China/ overseas, CCC is also engaged in railway construction, participating in BT The main downside risk to our investment call on CCC and BOT infrastructure projects in China, and overseas would be funding issues at the local government level, infrastructure construction, etc. which could have a negative impact on CCC. Within its construction segment, over the past several A secondary downside risk would be lower-than- years, CCC has diversified into project design, dredging, expected margin expansion for domestic projects. port machinery manufacturing and some non-core segments. CCC’s dredging business is the largest in China and the third-largest worldwide currently.

- 76 - China Railway Sector 9 January 2015

One of CCC’s subsidiaries, Zhenhua Heavy Machinery (about 7-8% of the company’s annual revenue), which is listed on the Shanghai Stock Exchange (ticker: 600320 SS), is the world’s largest manufacturer of container cranes by revenue, with about a 75% market share.

CCC’s revenue stream is heavily reliant on the China Government’s infrastructure construction policy and its monetary policy.

CCC was listed on the Hong Kong Stock Exchange in 2006 and the Shanghai Stock Exchange in 2012, and is a state-owned enterprise under the SASAC. CCC’s major shareholder is its parent company, China Communication Construction Group (CCCG), with a 63.8% stake currently.

 CCC: breakdown of total revenue (2013) Others & Port machinery eliminations 7.0% 1.1% Dredging 9.5%

Design 5.6%

Construction 76.7%

Source: Company

 CCC: breakdown of construction revenue (2013) Others 7.4% Ports 18.6% Overseas 15.2%

BT/BOT 12.3%

Roads & bridges Railways 36.0% 10.6%

Source: Company

- 77 - China Railway Sector 9 January 2015

Daiwa’s Asia Pacific Research Directory

HONG KONG SOUTH KOREA Hiroaki KATO (852) 2532 4121 [email protected] Sung Yop CHUNG (82) 2 787 9157 [email protected] Regional Research Head Pan-Asia Co-head/Regional Head of Automobiles and Components; Automobiles; Kosuke MIZUNO (852) 2848 4949 / [email protected] Shipbuilding; Steel (852) 2773 8273 Mike OH (82) 2 787 9179 [email protected] Regional Research Co-head Capital Goods (Construction and Machinery) John HETHERINGTON (852) 2773 8787 [email protected] Jun Yong BANG (82) 2 787 9168 [email protected] Regional Deputy Head of Asia Pacific Research Oil; Chemicals; Tyres Rohan DALZIELL (852) 2848 4938 [email protected] Thomas Y KWON (82) 2 787 9181 [email protected] Regional Head of Product Management Pan-Asia Head of Internet & Telecommunications; Software – Internet/On-line Game Kevin LAI (852) 2848 4926 [email protected] Chief Economist for Asia ex-Japan; Macro Economics (Regional) TAIWAN Christie CHIEN (852) 2848 4482 [email protected] Rick HSU (886) 2 8758 6261 [email protected] Macro Economics (Regional) Head of Regional IT/Electronics; Semiconductor/IC Design (Regional) Junjie TANG (852) 2773 8736 [email protected] Steven TSENG (886) 2 8758 6252 [email protected] Macro Economics (China) IT/Technology Hardware (PC Hardware) Jonas KAN (852) 2848 4439 [email protected] Christine WANG (886) 2 8758 6249 [email protected] Head of Hong Kong and China Property IT/Technology Hardware (Automation); Pharmaceuticals and Healthcare; Consumer Leon QI (852) 2532 4381 [email protected] Kylie HUANG (886) 2 8758 6248 [email protected] Banking (Hong Kong, China); Broker (China); Insurance (China) IT/Technology Hardware (Handsets and Components) Anson CHAN (852) 2532 4350 [email protected]

Consumer (Hong Kong/China) INDIA Jamie SOO (852) 2773 8529 [email protected] Punit SRIVASTAVA (91) 22 6622 1013 [email protected] Gaming and Leisure (Hong Kong/China) Head of India Research; Strategy; Banking/Finance Lynn CHENG (852) 2773 8822 [email protected] Saurabh MEHTA (91) 22 6622 1009 [email protected] IT/Electronics (Semiconductor) (Greater China) Capital Goods; Utilities Dennis IP (852) 2848 4068 [email protected]

Power; Utilities; Renewables and Environment (Hong Kong/China) SINGAPORE John CHOI (852) 2773 8730 [email protected] Head of Hong Kong and China Internet; Regional Head of Small/Mid Cap Ramakrishna MARUVADA (65) 6499 6543 [email protected] Telecommunications (China/ASEAN/India) Joey CHEN (852) 2848 4483 [email protected] Steel (China) Royston TAN (65) 6321 3086 [email protected] Oil and Gas; Capital Goods Kelvin LAU (852) 2848 4467 [email protected] Head of Transportation (Hong Kong/China); Transportation (Regional) David LUM (65) 6329 2102 [email protected] Property and REITs Brian LAM (852) 2532 4341 [email protected] Transportation – Aviation (Hong Kong/China); Railway; Construction and Engineering Evon TAN (65) 6499 6546 [email protected] (China) Property and REITs Carrie YEUNG (852) 2773 8243 [email protected] Jame OSMAN (65) 6321 3092 [email protected] Transportation – Transportation Infrastructure (Hong Kong/China) Telecommunications (ASEAN/India); Pharmaceuticals and Healthcare; Consumer (Singapore) Jibo MA (852) 2848 4489 [email protected] Head of Custom Products Group Thomas HO (852) 2773 8716 [email protected] Custom Products Group

PHILIPPINES Bianca SOLEMA (63) 2 737 3023 [email protected] Utilities and Energy

- 78 - China Railway Sector 9 January 2015

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• For derivative and margin transactions etc., we may require collateral or margin requirements in accordance with an agreement made beforehand with you. Ordinarily in such cases, the amount of the transaction will be in excess of the required collateral or margin requirements. • There is a risk that you will incur losses on your transactions due to changes in the market price of financial instruments based on fluctuations in interest rates, exchange rates, stock prices, real estate prices, commodity prices, and others. In addition, depending on the content of the transaction, the loss could exceed the amount of the collateral or margin requirements. • There may be a difference between bid price etc. and ask price etc. of OTC derivatives handled by us. • Before engaging in any trading, please thoroughly confirm accounting and tax treatments regarding your trading in financial instruments with such experts as certified public accountants. *The amount of the trading commission cannot be stated here in advance because it will be determined between our company and you based on current market conditions and the content of each transaction etc.

When making an actual transaction, please be sure to carefully read the materials presented to you prior to the execution of agreement, and to take responsibility for your own decisions regarding the signing of the agreement with us.

Corporate Name: Daiwa Securities Co. Ltd. Financial instruments firm: chief of Kanto Local Finance Bureau (Kin-sho) No.108 Memberships: Japan Securities Dealers Association, The Financial Futures Association of Japan Japan Securities Investment Advisers Association Type II Financial Instruments Firms Association

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