Daqin Railway Co. Ltd.: Three Debates to Address Market
Daqin Railway Co. Ltd. | July 29, 2015 MORGAN STANLEY RESEARCH
July 29, 2015 MORGAN STANLEY ASIA LIMITED+ Edward H Xu, CFA Daqin Railway Co. Ltd. [email protected] +852 2239-1521 Watson Lau Three Debates To Address Market [email protected] +852 2239-1523 Victoria Wong, CFA Concerns; LT Beneficiary of Railway [email protected] +852 2239-7817 Reform Daqin Railway Co. Ltd. ( 601006.SS, 601006 CH ) Industry View Stock Rating Price Target Hong Kong/China Transportation & Infrastructure / China In-Line Overweight Rmb13.33 Stock Rating Overweight Industry View In-Line Price target Rmb13.33 Despite market concerns about macro slowdown, coal demand Up/downside to price target (%) 32 weakness and competition risks, we view DQR as a highly defensive Shr price, close (Jul 29, 2015) Rmb10.12 52-Week Range Rmb15.15-7.01 stock that is undervalued. More importantly, we view it as a theme Sh out, dil, curr (mn) 14,867 play on China’s railway industry reform. Mkt cap, curr (mn) Rmb150,452 EV, curr (mn) Rmb129,487 What's Changed? From: To: Avg daily trading value (mn) Rmb1,575 Daqin Railway Co. Ltd. Fiscal Year Ending 12/14 12/15e 12/16e 12/17e Price Target Rmb13.82 Rmb13.33 ModelWare EPS (Rmb) 0.95 1.00 1.08 1.13 Prior ModelWare EPS 1.06 1.25 1.30 1.27 (Rmb) Key market debates: To address various market concerns about the stock, we Consensus EPS (Rmb)§ 1.00 1.09 1.12 1.15 are introducing three debates: 1) Has the market priced in the competition Revenue, net (Rmb 53,971 51,338 53,707 55,205 risks from the new railway lines? (We think yes); 2) How significant are the mn) EBITDA (Rmb mn) 21,033 20,753 21,641 22,610 risks from the UHV power lines under construction? (We think the risks are ModelWare net inc 14,194 14,857 16,078 16,756 minor); and 3) Will there still be pricing upside after recent hikes? (We think (Rmb mn) yes). P/E 11.1 10.1 9.4 9.0 P/BV 1.9 1.6 1.5 1.4 Theme play on railway reform: While this has been on the cards for a long RNOA (%) 20.9 20.3 21.0 21.1 ROE (%) 18.4 17.7 17.6 16.9 time, we remain confident that China will ultimately restructure the railway EV/EBITDA 6.5 6.0 5.5 4.9 industry, which suffers from poor services, and low profitability and returns. Div yld (%) 4.5 4.9 5.3 5.6 We think potential SOE reforms would help improve management efficiency FCF yld ratio (%) 8.4 8.6 9.1 9.9 Leverage (EOP) (%) (25.0) (28.9) (32.3) (35.9) and incentives, while an increase in securitization would imply M&A Unless otherwise noted, all metrics are based on Morgan Stanley ModelWare framework § = Consensus data is provided by Thomson Reuters Estimates opportunities for the three listed railway names. e = Morgan Stanley Research estimates 1H15 preview: Despite an 8.5% YoY decline in coal throughput on the Daqin Line, we expect revenues to increase 4.6% YoY to Rmb27.6bn, thanks to the tariff hike implemented in Feb-15. Following the 5% YoY increase in profits in 1Q15, we expect 2Q15 profit to remain flat YoY due to weaker traffic performance. As result, we expect 1H15 profit to increase 3% YoY to Rmb7,377m. Morgan Stanley does and seeks to do business with Lower PT to Rmb13.33: We cut our DCF-based PT by 4%, based on 20%/17% companies covered in Morgan Stanley Research. As a result, cuts to 2015-16 earnings estimates led by 17%/16% lower traffic assumptions. investors should be aware that the firm may have a conflict of interest that could affect the objectivity of Morgan We are also introducing 2017 net profit at Rmb16.8bn, implying a CAGR of 6% Stanley Research. Investors should consider Morgan over 2014-17. Our estimates are 9%, 6% and 4% below consensus for 2015- Stanley Research as only a single factor in making their 17 as we are factoring in weaker-than-expected traffic performance in 1H15. investment decision. For analyst certification and other important disclosures, Dividend remains attractive: The stock offers a 5.7% 2016 dividend yield refer to the Disclosure Section, located at the end of this based on the current price. This is attractive, especially given the prospect of report. += Analysts employed by non-U.S. affiliates are not registered w ith FINRA, may further rate cuts. While we are projecting a 50% dividend payout for 2015-17, not be associated persons of the member and may not be subject to NASD/NYSE restrictions on communications w ith a subject company, public appearances and we see significant upside led by sustainable abundant free cash flows (9.7% trading securities held by a research analyst account.
1 Daqin Railway Co. Ltd. | July 29, 2015 MORGAN STANLEY RESEARCH FCF yield) that add to the strong cash balance. Moreover, the stock is trading at only 8.8x 2016 P/E and 5.0x EV/EBITDA, significantly below global peers' average levels of 15.4x and 8.3x. Key downside risks: 1) Market risk led by liquidity or shift in investor sentiment; 2) sustained macro weakness in domestic economy; and 3) other exogenous events.
2 Daqin Railway Co. Ltd. | July 29, 2015 MORGAN STANLEY RESEARCH
Investment Conclusion
Despite the 4% cut to our DCF-based price target due to lower traffic and earnings assumptions, we maintain our OW rating given 40% upside potential from the current price level. We think the decline in coal volume could be a cyclical rather than a secular trend. In particular, we are introducing three debates to address major market concerns on the stock. More importantly, we continue to see potential opportunities from China's railway industry reform and view DQR as a major beneficiary of this theme.
Investment Debates
Debate 1. Has the market priced in the competition risks from the new railway lines?
Market view: Uncertainties remain high regarding the future outlook for Daqin's traffic volumes. Competition could come from several new railway lines (e.g. Zhangtang, Zhunshuo, and Zhongnan (Wari)) under construction.
Our view: We think the current share price has factored in the traffic diversion risk, as it is implying 13% (or 60 million tons) less traffic volume than our base case assumption.
Our rationale: 1) Among the various new railway projects under construction, we think just two new lines could pose diversion risks to Daqin - the Zhangji Line and Dazhun Line (Exhibit 8), which are both connecting to Inner Mongolia (Jining / Ulanqab and Zhungeer). They could compete with Daqin's two feeder lines - Jingbao and Dazhun, which contributed 73.75m (-9% YoY) and 74.11m (+14.6% YoY) tons of coal throughput to Daqin Line in 2014. However, we are not concerned with the risks from other new lines such as Menghua Line and Zhongnan Line due to Daqin's strong cost advantage and low overlap in the hinterland.
2) Going forward, we expect limited traffic diversion risk as traffic from Dazhun Line could normalize in 2H15 after the launch of Zhunchi Line in Jul-14. While further traffic diversion may continue after Zhangji Line is extended to Caofeidian / Tangshan, the unit cost could remain at Rmb0.18-0.2/ton-km, significantly higher than Rmb0.135/ton-km on Daqin Line.
3) We believe the -8.5% YoY traffic decline on Daqin Line in 1H15 was due to both macro weakness and traffic diversions. As overall demand recovers when macro conditions stabilize, we expect increasing volumes from non-Inner Mongolia areas (e.g., Shanxi and Sha'anxi) to make up the shortfall. We think this is possible because Daqin Line could have turned away traffic from these areas due to insufficient capacity in previous years.
Where we could be wrong: 1) More serious traffic diversion led by low prices on some new lines. However, we think this is unlikely given the high construction cost of the new lines; 2) Sustained macro weakness could dampen the overall traffic outlook.
Debate 2. How significant are the risks from the UHV power lines under construction?
Market view: There will be high risks to railway traffic led by China's roll-out of the new grid system (e.g., UHV power lines) for cleaner and more efficient power transmission.
Our view: While this remains a valid concern for the coal transportation industry, we see limited company specific risk to Daqin.
Our rationale: 1) China's first UHV (ultra high voltage) power line was built in 2006 to transmit power from Southeast Shanxi (Changzhi) via Henan (Nanyang) to Hubei (Jingmen). The past decade has seen a significant increase in UHV power lines from 0km to 12,153km, with capacity increased to 110,200 MW as of 2014. The goal is to reach a total length of 64,000km by 2020. We estimate that total coal throughput transported through conventional modes (e.g. railways, highways and water) was reduced by about 133m tons (or 6%) in 2014 as a
3 Daqin Railway Co. Ltd. | July 29, 2015 MORGAN STANLEY RESEARCH result. Yet, China coal throughput by railways still managed to increase at a 9% CAGR (2006-2014).
2) Going forward, China may push forward to build more UHV power lines, based on the target transmission capacity of 82GW from 2015 onwards, equivalent to 130m tons of standard coal, we estimate. However, given the high cost associated with UHV power transmission, the Electric Power Planning & Engineering Institute estimates the optimal distance is below 1,800km (Exhibit 1), implying sustained cost advantages for the long- haul conventional mode of “rail + water”.
Exhibit 1: Unit Cost Curve: Transporting electricity vs. transporting coal
0.32 Unit Cost(Rmb/kWh)
0.3 1,808 km 0.28
0.26
0.24
0.22 Length(km) 0.2 0 500 1000 1500 2000 2500 By Electricity By Coal
Source: Electric Pow er Planning & Engineering Institute; Assumptions for above scenario: By coal: 2000km railw ay w ith 200mtpa capacity and 1000MVA pow er generator. By electricity: 800kV DC pow er line, 2000km at capacity of 8,000 MVA, pow er generator of 1000MVA. 3) For Daqin Line, we see limited risks because it serves as the backbone for long-haul coal transportation with distances over 2,000km. According to management, less than 10% of coal throughput is consumed by local plants while the majority of volumes are shipped to Qinhuandao terminal in South China.
Where we could be wrong: 1) More strict environmental regulations to require UHV power transmission in China; 2) Significant cost reduction in UHV transmission led by technological breakthroughs.
Debate 3. Will there still be pricing upside to DQR's tariffs after recent hikes?
Market view: After recent tariff hikes in 2014-15, further upside is limited, especially given the poor coal demand outlook. On the other hand, the low gas / diesel prices should reduce railways’ cost advantages by lowering effective trucking costs.
Our view: Despite the weak demand currently, we see further tariff upside in the longer term.
Our rationale: 1) Even after the tariff hikes recently, railway tariffs are still at a significant discount to trucking costs. With the 20% decline in gas / diesel prices, the average pricing levels are 10%-15% below the levels in the same period in 2014. However, we estimate the unit cost for coal transportation at over Rmb0.4/ton km by trucking, vs. Rmb0.13/ton km by railways.
2) With the support of infrastructure facilities such loading yards and connecting lines to terminals, equipped with specialized machinery, railways are able to handle large quantities of commodities at reasonably high speed. Normally, we estimate the maximum truckload capacity at 50 tons, versus 20,000 tons for a train. 4 Daqin Railway Co. Ltd. | July 29, 2015 MORGAN STANLEY RESEARCH Therefore railways have strong advantages in terms of operating capacity and efficiency.
3) NDRC has made significant progress in liberalizing railway tariffs in recent years. The floating mechanism from Aug-2015 will allow railway operators to charge a premium of up to 10% to the base rate set by NDRC officially. Although the timing is not ideal given overall demand weakness currently, we see future upside when the cycle improves.
4) DQR's existing tariffs include a Rmb0.033/ton (or 24%) “electricity surcharge fee” that goes to CRC. Should CRC abolish or leave this fee to DQR in the future, it would imply significant upside to effective tariffs for DQR.
Where we could be wrong: 1) Regulatory uncertainties on rail tariffs; 2) sustained demand weakness could delay the overall process of further tariff hikes.
5 Daqin Railway Co. Ltd. | July 29, 2015 MORGAN STANLEY RESEARCH
China's Railway Reform
To help investors better understand the industry reform theme, we summarize the status quo of China's railway industry as follows:
1. Low securitization: In terms of asset size, China had 98,000km of conventional rail lines and 9356km of high-speed lines in operation as of end-2014. However, the three listcos (e.g. DQR, GSR and Tielong) owned only 1,139 km of conventional lines in aggregate, 1.2% of the country’s total. According to the annual reports, the total assets of the three listcos amounted to Rmb143,575m as of end-2014, 3.1% of CRC’s as of the same period. Currently, there are 16 bureauxs and five companies under CRC (Exhibit 2).
Exhibit 2: China Railway Corporation Organization Chart
Qinghai-Tibet Railway Corp.
Guangzhou Railway(Group)Corp. Guangshen Railway (601333)
Urumqi Railway Bureau
Hohhot Railway Bureau
Harbin Railway Bureau
Lanzhou Railway Bureau
Kunming Railway Bureau
Nanchang Railway Bureau
China Railway Corporation Nanning Railway Bureau
Zhengzhou Railway Bureau
Jinan Railway Bureau
Taiyuan Railway Bureau Daqin Railway (601006)
Xi'an Railway Bureau
Shenyang Railway Bureau
Shanghai Railway Bureau
Wuhan Railway Bureau
Chengdu Railway Bureau
Beijing Railway Bureau
Source: Morgan Stanley Research 2. Corporatization of MoR: The milestone event in China’s railway industry reform was the dismantling of the Ministry of Railways in Mar-13 with the establishment of the new China Railways Corporation (CRC). This is viewed as part of China’s reform scheme to build a comprehensive national transport system. As the successor to MoR, CRC is a pure operator of China’s national railway system (including freight and passenger) but with no administrative function as previously possessed by MoR. 6 Daqin Railway Co. Ltd. | July 29, 2015 MORGAN STANLEY RESEARCH 3. High debt burden: According to CRC’s annual report, total debts amounted to Rmb3.1 trillion by the end of 2014, which broke down to Rmb759.1bn of bonds, Rmb14bn of foreign loans, and Rmb2.3 trillion of loans from domestic financial institutions. Given the high ratios of total debt / total assets (56%) and net debt / equity ratios (150%), we estimate the annual interest cost at Rmb73bn in 2015.
4. Onerous construction target: The government has set a target to build a network of 120,000km rail lines by 2020, which entails total capex of Rmb5,367bn for 2015-20, on our estimate. The long-term goal is to further expand the network to 280,000km by end-2050. As China’s national railway operator, CRC is responsible for investment, implementation and funding of specific construction plans.
5. Freight tariff hikes: To expand revenues, CRC had to Exhibit 3: Freight tariff hikes, 2002-2015 push for reform of the freight transport system by introducing tariff hikes (Exhibit 3) in recent years and 0.1100 gradually allowing a floating mechanism from Aug-15. 0.1000
0.0900
m 0.0800
Looking forward, we expect potential industry reform k - n o t
/ 0.0700 led by the government focusing on the following areas: b m
R 0.0600 1) Securitization – Going forward, we expect the 0.0500 0.0400 securitization ratio to increase as more national railway 0.0300 assets could be floated through new IPOs or asset 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 injections into existing platforms. In our view, the whole Normal Coal Shipping Tariff Daqin/Shuohuang Special Coal Shipping Tariff process may entail large restructuring within CRC, Source: NDRC, Morgan Stanley Research leading to significant M&A opportunities for DQR, which is China’s largest public railway operator. The CRC has yet to lay out clear plans on how it might pursue such a strategy.
2) Further tariff hikes – CRC will still need to improve the profitability and return profile of existing railway projects. Specifically, we see more upside to freight tariffs than to passenger prices because the direct impact on people’s lives would be less.
3) Revamping services – With increasing focus on the bottom line, CRC will need to become more market oriented and improve its service standards and quality, by launching more value-added services such as logistics, warehousing, and last-mile delivery to capture new opportunities led by e-Commerce.
4) Management incentives – As a critical part of the SOE reform, management ownership / incentive schemes could be launched to stimulate improvements in performance. Existing listcos such as DQR could serve as test fields of such initiatives, we think.
7 Daqin Railway Co. Ltd. | July 29, 2015 MORGAN STANLEY RESEARCH Exhibit 4: Railway Bureau in China
Source: Morgan Stanley Research
8 Daqin Railway Co. Ltd. | July 29, 2015 MORGAN STANLEY RESEARCH
Construction of New Rail Cargo Lines
As the majority of China's coal resources are located in the western and northern provinces (Shanxi, Shaanxi and Western Mongolia), while the major consumption areas are located in the populated eastern and southern provinces, coal must be transported long distances by railways, roads and water. Also, coal is not transported on north-southbound railway lines. It is first transported from the west to the east and then shipped from ports from the north to the south.
Exhibit 5: DQR: Railway lines under management
Operating No. of Railroads Departure & Destination Class Type Power Type length (km) Tracks Trunk Daqin Hanjialing (excl.) - Liucunnan 658.0 National Class 1 Double Electrified Fengshada Datong - Guoleizhuang 155.5 National Class 1 Double Electrified Nantongpu Yuci-Fenglingdu 478.6 National Class 1 Double Internal combustive Beitongpu Datong - Northern Taiyuan 335.5 National Class 1 Double Electrified Jinyuan Yuanping-Linqiu 184.6 National Class 2 Single Internal combustive Taijiao Xiuwen- Xiadian 190.8 National Class 2 Single Internal combustive Houyue Houmabei - Jiafeng 150.6 National Class 1 Double Electrified Houxi Houma - Yumenkou 76.1 National Class 2 Single Internal combustive Shitai Saiyu - Huanghouyuan 123.9 National Class 1 Double Electrified Branch Kouquan Pingwang - Kouquan 9.8 National Class 1 Double Electrified Ningke Ningwu - Kelan 95.3 National Class 1 Single Electrified Tailan Northern Taiyuan - Zhenchendi 55.4 National Class 2 Single Electrified Xishan Northern Taiyuan - Baijiazhuang 23.6 National Class 3 Single Electrified/Internal combustive Lanchun Fenhe - Shanglanchun 12.7 National Class 3 Single Internal combustive Xinhe Xinzhou - Hebian 39.7 National Class 3 Single Internal combustive Jiexi Jiexiu - Yangquanqu 46.9 National Class 2 Double Internal combustive Hub & Contact 87.6 Total 2,724.6
Source: Company Data, Morgan Stanley Research Exhibit 6: Existing Major Coal Railway Lines
Source: Company Data, Morgan Stanley Research The railways from coal supply regions can be divided into three routes:
Northern Routes: Transporting from northern Shanxi, northern Shaanxi and the western region of Inner Mongolia. Railway lines include Daqin Line, Shuohuang Line, Jitong Line and Fengshada Line, linking 9 Daqin Railway Co. Ltd. | July 29, 2015 MORGAN STANLEY RESEARCH Qinhuangdao Port, Tianjin Port and Huanghua Port.
Middle Routes: Transporting coal from central Shanxi. Railway Lines includes Shitai Line, Jingyuan Line and Taijiao Line, linking Qinhuangdao, Qingdao Port and Tianjin Port.
Southern Routes: Transporting coal from central and southern Shaanxi to Rizhao Port, Lianyun Port, Nanjing and Ankang. Railway Lines include Houyue Line and Houxi Line, Longhai Line, Xikang Line and Nongxi Line.
Exhibit 7: West-East Coal Transportation Routes
Departure Routes Transition Destination Jitong (Jining, Inner Mongolia - Tongliao, Liaoning) Northeast China West Mongolia Dazhun (Jungar Banner, Erdos - Datong, Shanxi) Datong Daqin Qinhuangdao Jinbao (Baotou - Datong) North Northern Shanxi Beitongpu (Northern Taiyuan - Datong) Datong Daqin Qinhuangdao Fengsha Qinhuangdao Port, Tianjin Port Baoshen ( Shenmu, Shaanxi - Baotou, Inner Mongolia) Jinbao (Baotou - Datong) Daqin Qinhuangdao Port Northern Shaanxi Shenshuo (Shenmu, Shaanxi - Shuozhou, Shanxi) Beitongpu (Datong - Northern Taiyuan) Daqin Qinhuangdao Port Shuohuang ( Shuozhou, Shanxi - Huanghua Port) Huanghua Port, Tianjin Port Jinyuan (Taiyuan - Beijing) Beijing Qinhuangdao Port, Tianjin Port Middle Middle and Southeast of Shanxi Shitai (Taiyuan - Shijiazhuang) Dezhou - Jinan Qingdao Port Taijiao (Taiyuan - Jiaozuo) Changzhibei - Handan - Jinan Qingdao Port Houyue (Houma, Shanxi - Jiyuan, Henan Houma - Yueshan - Xinxiang - Heze - Yanzhou Rizhao Port South Middle and Southwest of Shanxi Longhai Lianyun Port Houxi (Houma, Xi'an Shaanxi) Xikang (Xi'an, Shaanxi - Ankang, Shaanxi) Ankang Ningxi (Xi'an, Shaanxi - Nanjing, Jiangsu) Nanjing
Source: Morgan Stanley Research Among the three routes, the northern route, which includes two major lines - Daqin Line and Shuohuang Line - is the most important.
Having long suffered from a coal transportation bottleneck, in 2014, NDRC announced plans to increase coal railway transportation capacity to 3bn tons per year by 2020. This follows the government's energy strategy to move coal capacity and production to the west and consolidate the coal producers. Currently, a number of projects have commissioned, including the expansion of current capacity on Shuohuang line and Lanxin line, and the construction of Central Southern Route (Zhongnan).
From Daqin Railway's standpoint, the new railway lines may divert its volume.
Exhibit 8: Railways under construction
Source: Morgan Stanley Research D etails of the new Railway Lines around Daqin Line
10 Daqin Railway Co. Ltd. | July 29, 2015 MORGAN STANLEY RESEARCH Exhibit 9: Newly built coal railway line
Length (km) From To Capacity Launch Year Zhangtang Railway 528 Zhangjiakou Caofeidian 200mtpa 2016 Wari Railway 1260 Watang Rizhao Up to 250mtpa Jan-15 Shuohuang Expansion 588 Shanxi Huanghua 240mtpa expand to 350mtpa 2015 Zhunshuo Railway 215 Zhunger ShenShuo 50mtpa 2015/2016 Menghua Railway 1837 Haolebaoji Central China 200mtpa 2017
Source: Morgan Stanley Research Zhang-Tang Railway (ZhunCao Line)
This is an extension from the Zhangji (Zhangjiakou - Jining) railway line, which connects to Jingbao line (Beijing- Baotou). It covers Zhangjiakou City (Wanquan, Xuanhua, Chicheng), Cengde City (Fengning, Luanping, Xinglong) and Tangshan City (Zunhua, Fengrun, Fengnan, Luannan) and ends in Caofeidian.
Zhang-Tang will be 528km long. The total investment amounts to Rmb40bn. It will have 17 stations, 174 bridges (137 kilometers), and 85 tunnels (230 kilometers). The railway is designed mainly for freight transport, with designed capacity of over 200 million tons.
On March 10, 2015, according to Huigang Zhu, the deputy director general of Beijing Railway Bureau , Zhang- Tang railway will be ready to operate by Dec-2015.
Impact on Daqin: As this line will connect Zhangji line to Caofeidian, a major coal terminal in the Bohai Bay area, it could further divert the coal volumes sourced from Ulanqab in Inner Mongolia. However, given the tariff could be set at Rmb0.18-0.2/ton-km, significantly above Rmb0.135/ton-km for Daqin, the risk of traffic diversion could be limited.
Zhun-Shuo Railway
This will be another line connecting from Zhungeer, in addition to the existing Dazhun and Zhunchi lines. Zhungeer is a major coal producing area in Inner Mongolia, which supplied 74.11m (+14.6% YoY) tons of coal throughput to Daqin Line in 2014 via Dazhun line. When the new Zhunchi line started operating in 2014, it had some impact on Daqin's volume. The new Zhunshuo line will connect Zhungeer to Shuohuang line, a major West-East coal transportation channel south of Daqin line.
Impact on Daqin: We expect minor incremental risk to Daqin as Zhunshuo is just another line in addition to the existing Zhunchi line. Moreover, the tariff could be high to reflect the increasing construction costs nowadays, we believe.
Expansion of Shuohuang Line
Shuohuang transport capacity will increase from 240 mtpa to 350 mtpa by 2015. Shenhua Group plans to expand capacity by 30-40 mtpa to reach 400-600 mtpa in the long term. The supporting Zhunshuo line may divert coal volume from Zhunger to Shuozhou to Huanghua from the original line Zhunger to Datong to Qinhuangdao.
Impact on Daqin: We believe the expansion of Shuohuang line reflects the capacity bottleneck on Daqin line, as Shuohuang's increased capacity would tend to absorb the volumes that cannot be handled by Daqin. Moreover, given DQR's 41.16% stake in Shuohuang line, it will share the benefit of future volume growth.
11 Daqin Railway Co. Ltd. | July 29, 2015 MORGAN STANLEY RESEARCH Given China's long term strategy to tackle air pollution problems and reduce reliance on power generated from fossil fuels (in particular coal), the government plans to develop long-distance, large capacity and cross provincial power transmission lines utilizing ultra high voltage (UHV) power line technology.
UHV is defined as voltage of 1000 KV or above in AC and 800 KV or above in DC to delivery large quantities of power over long distance with less power loss than the most commonly used 500-KV line. A single UHV can carry 10 GW of power. The DC lines are used mostly in P2P power transmission while the AC line is used in grid transmission.
Exhibit 10: Current UHV Projects
Voltage Class AC/DC Project Capacity (GW) Expected Commission Date (KV) Jindongnan - Nanyang-Jingmen 1000 18 2009/2011 Huainan-Zhejiang (North) - Shanghai 1000 21 2013 Zhejiang (North) - Fuzhou 1000 18 2014 AC Huainan - Nanjing - Shanghai 1000 12 2016 IM Xilingele - Shandong 1000 15 2016 IM (West) - Tianjin (South) 1000 24 2016 Yuheng - Weifang 1000 15 2017 Xiangjiaba - Shanghai ±800 12.8 2010 Jinping - Sunan ±800 14.4 2012 DC Hami (South) - Zhengzhou ±800 16 2014 Xiluodu - Zhejiang (West) ±800 16 2014 Ningxia (East) - Zhejiang ±800 16 2016
Source: State Grid, Morgan Stanley Research; Note: Project up to the end of May 2015 The goal for utilizing the UHV power line transmission is for cleaner and more efficient use of resources. However, progress has been hindered by high costs and technological problems. Nevertheless, the plan has accelerated since April 2014, when Premier Li Keqiang requested to speed up construction, claiming this program is the only way to change the energy development pattern, ensure energy security, and facilitate economic and social development, as stated by SGCC (State Grid Corporation of China).
On May 17, 2014, the government announced that the energy industry would tackle air pollution by transferring power from West to East China. The plan includes the transfer of 2GW of power by 2015 to Beijing-Tianjin- Hebei-Shandong (BTTS) from the energy base in West China. By 2017, the target is for 82GW in power to be transferred to northern, central and southern China.
On May 28, 2014, the government released the details of the new UHV transmission lines that would be involved in the West-East power transfer. We expect construction of the lines to start before the end of 2015. The general manager of the State Grid, Mr. Liu Zhenya, has stated that the State Grid will accelerate the construction of UHV transmission lines and complete 8,310km a year in 2015-2018. He estimates the total length of UHV lines will increase to 64,000km by 2020 from 10,000 km currently.
12 Daqin Railway Co. Ltd. | July 29, 2015 MORGAN STANLEY RESEARCH Exhibit 11: Newly Built UHV
Source: State Grid, Morgan Stanley Research; Note: Project up to the end of May 2015 U HV vs. Conventional Coal Transportation
According to the 2014 power market trading information conference held by SGCC on Jan 22, 2015, overall cross-provincial and cross-regional transactions stood at 725.2 billion kwh of electricity in 2014, marking an increase of 12.0% YoY. The “Three Hua” regions (North China, East China & Central China) accounted for 391.2 billion kwh, equivalent to the power derived from 133.01 million tons of coal, which would reduce carbon dioxide emissions of 345.82 million tons.
In view of the ongoing UHV projects in China into 2017, assuming yearly utilization of 5000 hours and 317 tons of standard coal for 1 Gwh of power, we estimate the new projects would cut the transportation of standard coal to East China by 130m tons. In aggregate, we estimate total standard coal by conventional transportation savings of 263m tons, or 12% of the total coal transported by railways in China in 2013.
Exhibit 12: Reduction in standard coal transported from the launch of new UHV projects
Annual Annual Power Conversion Factor AC/DC Project Capacity (GW) Coal saved to be transported (m ton) Utilization (Hrs) Generation (GWh) (Coal ton to GWh) Huainan - Nanjing - Shanghai 12 5000 60000 317 19 IM Xilingele - Shandong 15 5000 75000 317 24 AC IM (West) - Tianjin (South) 24 5000 120000 317 38 Yuheng - Weifang 15 5000 75000 317 24 DC Ningxia (East) - Zhejiang 16 5000 80000 317 25 Total 130
Source: Morgan Stanley Research Estimates
13 Daqin Railway Co. Ltd. | July 29, 2015 MORGAN STANLEY RESEARCH
Daqin Railway (DQR): Financial Summary
Exhibit 13: DQR: Financial Summary, 2013-17E
Profit & Loss Statements Ratio Analysis Year to Dec (Rmb Mn) 2012 2013 2014 2015E 2016E 2017E Growth% 2012 2013 2014 2015E 2016E 2017E Revenue Railroad revenues 2.1 10.6 6.2 2.6 4.7 2.8 Railroad businesses 44,599 49,348 52,422 53,777 56,297 57,893 Cargo 1.4 11.7 8.8 3.7 4.6 3.0 Non-railroad businesses 1,602 1,995 1,548 1,425 1,453 1,468 - Coal 1.4 11.7 8.8 3.4 4.0 3.0 Net Revenue after VAT 46,201 51,343 53,971 51,338 53,707 55,205 - Other cargo 1.4 11.7 8.8 5.7 8.0 3.0 Railroad businesses 27,059 30,493 32,347 33,176 34,435 35,199 Passenger 3.1 4.7 (5.9) 0.7 6.0 3.0 Non-railroad businesses 1,419 1,814 1,388 1,419 1,441 1,441 Others 6.7 8.6 (2.1) (6.0) 4.0 1.0 Cost contribution from acquired assets ------Non-railroad revenues 22.8 24.5 (22.4) (8.0) 2.0 1.0 Total Costs of Sales 28,479 32,307 33,735 34,594 35,876 36,641 Total Revenue 2.7 11.1 5.1 (4.9) 4.6 2.8 Business taxes and surcharges / VAT1,367 1,530 220 2,628 2,795 2,915 Gross profit (4.7) 7.4 6.3 (17.3) 6.5 4.1 G&A expenses 2,768 3,341 3,914 1,644 1,677 1,694 Operating Profit (3.8) 9.5 12.1 4.6 8.2 4.2 Financial income (-)/expenses(+) 862 664 479 250 112 (42) Profits before taxes (3.5) 9.3 12.4 4.7 8.2 4.2 Assets impairment loss (0) (0) 5 5 5 5 Net profit (1.7) 10.3 11.8 4.7 8.2 4.2 Investment income (Shuohuang & QH2D,)066 2,693 2,540 2,921 3,272 3,272 EBITDA (2.1) 7.7 8.7 0.4 5.2 3.9 Operating Profit 14,790 16,194 18,158 19,001 20,557 21,420 EPS (1.7) 10.3 11.8 4.7 8.2 4.2 Other income 27 16 44 44 44 44 Margin% Other expenses 112 139 132 132 132 132 EBITDA margin 43.6 42.2 43.7 46.1 46.4 46.9 Profits before taxes 14,706 16,071 18,069 18,913 20,469 21,332 Operating margin 32.0 31.5 33.6 37.0 38.3 38.8 Tax expenses 3,201 3,376 3,880 4,061 4,396 4,581 Net margin 24.9 24.7 26.3 28.9 29.9 30.3 Net profit 11,504 12,692 14,185 14,853 16,074 16,752 Return% ROE 18.3 18.1 18.4 17.7 17.6 16.9 EPS (Rmb) 0.77 0.85 0.95 1.00 1.08 1.13 RNOA 24.2 25.6 24.5 24.4 25.4 25.3 DPS (Rmb) 0.39 0.43 0.48 0.50 0.54 0.56 Gearing Net Debt/Equity (%) NC NC NC NC NC NC Balance Sheets Net Int. Coverage (x) 23.4 32.7 49.2 94.6 223.0 (615.9) Year to Dec (Rmb Mn) 2012 2013 2014 2015E 2016E 2017E Operational Traffic 2012 2013 2014 2015E 2016E 2017E Fixed assets 65,741 64,308 63,277 63,174 63,249 62,610 Cargo (Mn tons) 749 759 755 700 722 732 WIP Construction 1,780 2,989 3,344 3,344 3,344 3,344 YoY Chng -2% 1% -1% -7% 3% 1% Intangible assets 4,347 4,246 4,134 4,020 3,906 3,792 Coal 584 595 613 564 575 581 Others 15,027 18,047 19,129 19,129 19,129 19,129 YoY Chng -2% 2% 3% -8% 2% 1% Total non-current assets 86,895 89,591 89,884 89,666 89,627 88,874 Coal (by Daqin line) 426 445 450 415 427 436 Cash and cash equivalents 7,837 8,785 9,639 15,064 20,725 27,363 YoY Chng -3% 5% 1% -8% 3% 2% Account receivables 2,083 2,081 2,317 2,204 2,306 2,370 Other cargo 166 164 142 136 147 151 Other receivables 672 421 972 925 968 995 YoY Chng 0% -1% -14% -4% 8% 3% Others 3,081 3,307 3,522 6,167 8,833 11,473 Cargo turnover (bn TK) 355 366 370 348 362 374 Total current assets 13,673 14,594 16,450 24,360 32,831 42,200 YoY Chng 0% 3% 1% -6% 4% 3% Short-term borrowings 3,994 7,494 4,998 4,998 4,998 4,998 Coal 318 337 354 333 346 356 Account payables 3,838 3,555 3,944 4,044 4,194 4,283 YoY Chng 3% 6% 5% -6% 4% 3% Other payables 5,031 5,195 6,460 6,624 6,869 7,016 Other cargo 37 29 16 15 16 17 Others 3,581 3,406 3,339 3,339 3,339 3,339 YoY Chng -19% -23% -44% -5% 8% 6% Total current liabilities 16,443 19,649 18,740 19,005 19,400 19,636 Passengers (000) 59,200 60,230 61,560 62,000 65,720 67,692 Long-term borrowings - 686 1,013 1,013 1,013 1,013 YoY Chng 0% 2% 2% 1% 6% 3% Total non-current liabilities 13,705 6,352 2,583 2,583 2,583 2,583 Pax (bn PK) 15.60 15.20 14.00 14.42 15.14 15.60 Net assets 70,419 77,499 83,999 91,425 99,463 107,842 YoY Chng -3% -3% -8% 3% 5% 3% Shareholders' capital 14,867 14,867 14,867 14,867 14,867 14,867 Capital reserve 24,925 24,888 23,682 23,682 23,682 23,682 MW Valuations 2012 2013 2014 2015E 2016E 2017E Surplus reserve 6,401 7,671 9,089 9,089 9,089 9,089 P/E 8.7 8.7 11.1 9.5 e 8.8 e 8.8 e Retained earnings 24,025 29,648 36,162 43,588 51,625 60,001 P/B 1.4 1.4 1.9 1.5 e 1.4 e 1.4 e Total Shareholders' equity 70,218 77,073 83,799 91,226 99,263 107,638 EV/EBITDA 4.5 4.9 6.5 5.5 e 5.0 e 5.0 e Total Equity 70,419 77,499 83,999 91,425 99,463 107,842 Dividend Yield (%) 5.8% 5.8% 4.5% 5.3% e 5.7% e 5.7% e
Cash Flow Statements Year to Dec (Rmb Mn) 2012 2013 2014 2015E 2016E 2017E Source: Morgan Stanley Research Estimates NOPAT 12,246 13,317 14,634 15,117 16,230 16,787 NC = Net cash; NA = Not available D&A 4,483 4,820 4,931 4,418 4,239 4,499 CAPEX 3,928 4,719 5,465 4,450 4,450 3,950 Changes in working capital (2,152) (811) 251 382 187 106 Free cash flow 10,648 12,608 14,352 15,468 16,206 17,442 Proceeds from loan - 686 333 - - - Cash paid from dividend and interest 6,646 6,636 7,055 7,677 8,149 8,376 Other cash flows (880) (5,710) (6,776) (2,366) (2,396) (2,429) Cash at beginning of year 4,714 7,837 8,785 9,639 15,064 20,725 Cash at end of year 7,837 8,785 9,639 15,064 20,725 27,363
Source: Company Data, Morgan Stanley Research (E) estimates
14 Daqin Railway Co. Ltd. | July 29, 2015 MORGAN STANLEY RESEARCH
Risk-Reward Snapshot: Daqin Railway (601006.SS, Rmb9.50, OW, PT Rmb13.33)
Risk-Reward View: Attractively Valued Investment Thesis Rmb 20
18 Rmb17.98 (+89%) Cut TP by 4% to Rmb13.33, implying 40% upside after stock correction of 33% over the past three 16 months. 14 Rmb13.33 (+40%) We forecast OP margin of 38% and ROE of 18% in 12 2016. Rmb9.50 10 Trading at 8.8x 2016 P/E but offering a 5.7%
8 Rmb8.06 (-15%) dividend yield, DQR remains attractive to global investors who wish to seek value from China's A- 6 share market. 4 2 Potential Catalysts 0 Jul-13 Jan-14 Jul-14 Jan-15 Jul-15 Jan-16 Jul-16 Railway industry reforms with potential asset
Price Target (Jul-16) Historical Stock Performance Current Stock Price WARNINGDONOTEDIT_RRS4RL~601006.SS~ injections. Further liquidity inflows from global investors as Price Target Rmb13.33 Probability-weighted DCF valuation: bull case (10%), base case facilitated by the MMA program. (85%), and bear case (5%). DCF: WACC of 11.2% Recovery in volume momentum in 2H15. Potential increase in dividend payout ratio (at 50% Bull Rmb17.9 Daqin line coal transportation tariffs rise 15%: This reflects far- currently). 8 reaching industry reform to deregulate fixed tariff mechanism. We Implied 16.6x 2016e P/E also assume better cost control. Key Downside Risks Base Rmb13.0 Potential tariff hikes largely offset VAT reform: Coal shipping volume drops by 8% in 2015 and grows by 2% and 1% for 2016- Delay in tariff hike due to sluggish coal demand 9 throughout the industry. Implied 12.1x 2016e P/E 17e. Passenger volume climbs 1%, 6%, and 3% in 2015-17e, respectively. 2% terminal growth. Market risk led by liquidity or shift in investors’ sentiment. Bear Rmb8.06 Coal shipping demand falls 15-20% YoY during 2015-17e: Higher than expected volume diversion from other Implied 7.5x 2016e P/E Operating cost overruns cut OP margins by 10-15ppt in 2015- railway lines. 17e. Sustained macro weakness in domestic economy. Other exogenous events.
15 Daqin Railway Co. Ltd. | July 29, 2015 MORGAN STANLEY RESEARCH
Investment Thesis
2 015 1H Preview
Following an increase of 5% in 1Q15 net profit (6.3% coal volume decline), we are forecasting 2Q15 net profit at Rmb3,661m, flat YoY and down 1% QoQ, led by a more severe decline in coal volume (-10.6%) in 2Q15, but partly offset by the tariff hike in Feb-15. As a result, we expect 1H15 net profit to reach Rmb7,377m (3% YoY growth), with coal volume down 8.5% YoY. C ut PT to Rmb13.33
We continue to value DQR on a probability-weighted approach based on our DCF model, due to the stable cash flow generated from railway passenger and cargo operations. We continue to apply 85% probability for the base case scenario given DQR's highly predictable cash flows and earnings outlook.
We are applying a 10% probability to our bull case scenario to reflect upside risk led by higher traffic growth and tariff hikes. Relatively, we think the chance of this scenario is higher than that for the bear case scenario as we expect further improvement led by macro recovery and industry reform in the long run.
We are applying a 5% probability to our bear case scenario to reflect downside risk led by a sharp decline in traffic and cost overruns. Given DQR's defensive nature, we think the probability for further downside risk is low, especially as traffic already slowed in 2014 amid macro weakness.
Base Case: 85% weighting (unchanged) Exhibit 14: DQR: WACC Assumption Scenario Value: Rmb13.09, from Rmb13.58 previously We calculate the new DCF value of our base-case scenario at Rmb13.09, after fine tuning our model to reflect the weakness YTD in coal transport volume. We cut our volume assumptions and factor in a stronger than expected tariff hike in 2015.
Bear Case: 5% weighting (unchanged) Scenario Value: Rmb8.06, from Rmb8.36 previously Our bear-case scenario reflects a more pessimistic Source: Morgan Stanley Research estimates outlook, led by severe slowdown in GDP growth. We assume that coal shipping demand via the Daqin Line drops 15-20% YoY during 2015-17, while OP margin declines because of cost overruns.
Bull Case: 10% weighting (unchanged) Exhibit 15: DQR: Probability-weighted Price Scenario Value: Rmb17.98, from Rmb18.65 Target previously In our bull case scenario, we assume a 15% YoY rail freight tariff hike in 2015-17 for both coal and general goods. We also assume extra cost savings on operating items.
Source: Morgan Stanley Research Earnings Adjustments for 2015, 2016 and 2017
With our adjustments to coal and pax throughput volume and operating cost items based on 2014 actual 16 Daqin Railway Co. Ltd. | July 29, 2015 MORGAN STANLEY RESEARCH results, we cut our earnings estimates by 20% and 17% for 2015 and 2016, respectively. We introduce 2017 net profit at Rmb16,752m. Our new forecasts are below Exhibit 16: DQR: Morgan Stanley Estimates vs. consensus estimates by 9%, 6% and 4% for 2015, 2016, Consensus and 2017, respectively.
Year to Dec 31 2015E 2016E 2017E DQR (601006.SS) MS estimates Rmb mn 14,853 e 16,074 e 16,752 e Consensus estimates Rmb mn 16,263 17,019 17,478 % variance -9% -6% -4%
Source: Thomson Reuters Consensus, Morgan Stanley Research
17 Daqin Railway Co. Ltd. | July 29, 2015 MORGAN STANLEY RESEARCH Key downside risks to our earnings and valuation include: 1. Market risk led by liquidity or shift in investors’ sentiment: Overall sentiment toward the A- share market has been very volatile for the past month. A potential shift in sentiment and liquidity may affect Daqin's share price. 2. Stronger than expected coal volume diversion from other railway lines 3. Sustained macro weakness in domestic economy 4. Other exogenous events
Exhibit 17: DQR: Forward P/E, Jan-2007 to Exhibit 18: DQR: Forward P/B, Jan-2007 to Current Current
60.00 10.00 25% Mean=2.5x Mean=15.4x 9.00 50.00 23% 8.00 7.00 40.00 21% E B / / 6.00 P P
d d r 30.00 r 5.00 19% a a w w r r o o 4.00 F 20.00 F 17% 3.00 2.00 10.00 15% 1.00 - - 13% 7 8 0 0 2 3 7 8 9 9 1 1 2 3 4 4 7 8 0 2 3 6 9 1 6 7 8 1 2 3 7 7 8 8 9 9 0 0 1 1 2 2 3 3 4 4 9 0 0 0 1 1 1 0 0 1 0 0 0 0 1 1 1 1 1 1 0 0 1 1 1 1 0 0 0 1 1 1 0 1 0 0 1 1 1 1 0 0 0 0 1 1 1 1 1 1 / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / 3 3 3 3 3 3 3 3 3 3 3 3 3 3 3 3 3 3 3 3 3 3 3 3 3 3 3 3 3 3 3 3 3 3 3 3 3 3 3 3 3 3 3 3 3 3 3 3 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / / 4 8 4 8 4 8 4 8 4 8 4 8 4 8 4 8 2 2 2 2 2 2 2 2 4 8 4 8 4 8 4 8 4 8 4 8 4 8 4 8 2 2 2 2 2 2 2 2 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1 1
Forward P/E Mean +1std -1std Forward P/B Mean +1std -1std ROE
Source: Bloomberg, Morgan Stanley Research Source: Bloomberg, Morgan Stanley Research Exhibit 19: DQR: Forward EV/EBITDA, Jan-2007 to Current
35.00 Mean=8.5x 30.00
25.00 A D T I
B 20.00 E / V E
d 15.00 r a w r
o 10.00 F
5.00
- 8 1 7 8 9 0 1 1 2 3 4 7 8 9 0 2 3 4 6 7 9 0 2 3 0 0 0 0 1 1 1 1 0 0 0 1 1 1 1 1 1 0 0 0 1 1 1 1 / / / / / / / / / / / / / / / / / / / / / / / / 3 3 3 3 3 3 3 3 3 3 3 3 3 3 3 3 3 3 3 3 3 3 3 3 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 / / / / / / / / / / / / / / / / / / / / / / / / 4 8 4 8 4 8 4 8 4 8 4 8 4 8 4 8 2 2 2 2 2 2 2 2 1 1 1 1 1 1 1 1
Forward EV/EBITDA Mean +1std -1std
Source: Bloomberg, Morgan Stanley Research
18 Daqin Railway Co. Ltd. | July 29, 2015 MORGAN STANLEY RESEARCH Exhibit 20: DQR: New vs. Old Estimates, 2015-2017e
2015E 2016E 2017E Year to Dec (Rmb Mn) New Old % Diff New Old % Diff New Old % Diff Revenue Railroad businesses 53,777 63,769 -16% 56,297 66,348 -15% 57,893 57,893 0% Cargo 44,507 52,082 -15% 46,560 54,018 -14% 47,956 47,956 0% - Coal 37,707 44,614 -15% 39,215 45,952 -15% 40,391 40,391 0% - Other cargo 6,801 7,468 -9% 7,345 8,066 -9% 7,565 7,565 0% Passenger 4,814 5,937 -19% 5,103 6,293 -19% 5,256 5,256 0% Others 4,456 5,750 -23% 4,634 6,037 -23% 4,680 4,680 0% Non-railroad businesses 1,425 1,480 -4% 1,453 1,524 -5% 1,468 1,468 0% Revenue contribution from acquired assets Net Revenue after VAT 51,338 60,681 -15% 53,707 63,122 -15% 55,205 55,205 0% Cost of Sales Railroad businesses 33,176 34,939 -5% 34,435 36,750 -6% 35,199 35,199 0% Materials 1,716 2,086 -18% 1,716 2,190 -22% 1,716 1,716 0% Electricity&Fuel 3,387 3,534 -4% 3,319 3,534 -6% 3,253 3,253 0% Depreciation 4,304 4,803 -10% 4,125 4,633 -11% 4,385 4,385 0% Staff costs 10,395 10,560 -2% 11,435 11,828 -3% 12,007 12,007 0% Overhaul expenses 1,431 1,690 -15% 1,445 1,774 -19% 1,445 1,445 0% Cargo train usage expenses 2,960 3,081 -4% 3,108 3,235 -4% 3,108 3,108 0% Communication services 320 292 9% 320 292 9% 320 320 0% Passengers train services 2,475 2,410 3% 2,599 2,531 3% 2,599 2,599 0% Heating supply 412 350 18% 420 357 18% 420 420 0% Cargo train services 2,097 2,304 -9% 2,160 2,373 -9% 2,160 2,160 0% Rental 315 279 na 330 293 na 330 330 na Land and Building Rental 403 409 -1% 407 413 -1% 407 407 0% Others 2,961 3,140 -6% 3,050 3,297 -7% 3,050 3,050 0% Non-railroad businesses 1,419 1,426 -1% 1,441 1,460 -1% 1,441 1,441 0% Maintenance 347 427 -19% 351 440 -20% 351 351 0% Materials 315 258 22% 325 265 22% 325 325 0% Empty&loading 2 2 10% 2 2 10% 2 2 0% Managing expenses for trains 70 93 -24% 74 98 -24% 74 74 0% labour 76 73 4% 82 82 0% 82 82 0% Others 608 573 6% 608 573 6% 608 608 0% Cost contribution from acquired assets Total Costs of Sales 34,594 36,365 -5% 35,876 38,210 -6% 36,641 36,641 0% % YoY 3% 7% 4% 5% 2% 2% Gross profit 16,743 24,316 -31% 17,831 24,911 -28% 18,565 18,565 0% % YoY -17% 15% 6% 2% 4% -3% Railroad businesses 20,602 28,830 -29% 21,862 29,598 -26% 22,693 22,693 0% Non-railroad businesses 6 54 -89% 12 64 -82% 26 26 0% Gross margins 33% 40% -7% 33% 39% -6% 34% 34% 0% Railroad businesses 38% 45% -7% 39% 45% -6% 39% 39% 0% Non-railroad businesses 0% 4% -3% 1% 4% -3% 2% 2% 0% Business taxes and surcharges / VAT 2,628 3,227 -19% 2,795 3,374 -17% 2,915 2,915 0% Business taxes and surcharges (Acquired assets) ------G&A expenses 1,644 4,250 -61% 1,677 4,377 -62% 1,694 1,694 0% G&A expenses (Acquired assets) ------Financial income (-)/expenses(+) 250 378 -34% 112 195 -43% (42) (42) 0% Financial income (-)/expenses(+) (Acquired assets) ------Assets impairment loss 5 0 1911% 5 0 1911% 5 5 0%
Investment income (Shuohuang & QHD) 2,921 2,756 6% 3,272 3,087 6% 3,272 3,272 0%
Operating Profit 19,001 23,786 -20% 20,557 24,803 -17% 21,420 21,420 0% Operating margin 37% 39% -2% 38% 39% -1% 39% 39% 0% Other income 44 16 177% 44 16 177% 44 44 0% Other income (Acquired assets) ------Other expenses 132 139 -5% 132 139 -5% 132 132 0% Other expenses (Acquired assets) Profits before taxes 18,913 23,662 -20% 20,469 24,680 -17% 21,332 21,332 0% Tax expenses 4,061 5,150 -21% 4,396 5,371 -18% 4,581 4,581 0% Effective tax rate 21% 22% 21% 22% 21% 21%
Tax expenses (Acquired assets) Minority interest (2) (2) 0% (3) (3) 0% (3) (3) 0% Net profit 14,853 18,513 -20% 16,074 19,310 -17% 16,752 16,752 0.0% Net margin 29% 31% 30% 31% 30% 30% EPS Basic 1.00 1.25 -20% 1.08 1.30 -17% 1.13 1.13 0% Diluted 1.00 1.25 -20% 1.08 1.30 -17% 1.13 1.13 0%
2015E 2016E 2017E Traffic New Old % Diff New Old % Diff New New % Diff Cargo (Mn tons) 737 885 -17% 742 885 -16% 746 746 0% Coal 581 701 -17% 581 701 -17% 581 581 0% Coal (by Daqin line) 436 477 -9% 436 477 -9% 436 436 0% Other cargo 156 184 -15% 161 184 -12% 166 166 0%
Cargo turnover (bn TK) 385 419 -8% 389 419 -7% 389 389 0% Coal 367 383 -4% 371 383 -3% 371 371 0% Coal (by Daqin line) 287 314 -9% 287 314 -9% 287 287 0% Other cargo 18 37 -51% 19 37 -49% 19 19 0%
Passengers (000) 69,722 74,584 -7% 71,814 74,584 -4% 73,250 73,250 0% Pax (bn PK) 15.60 18.65 -16% 15.60 18.65 -16% 15.60 15.60 0%
Source: Morgan Stanley Research estimates
19 Daqin Railway Co. Ltd. | July 29, 2015 MORGAN STANLEY RESEARCH
DQR: DCF Base Case Valuation
Exhibit 21: DQR: DCF Base Case Valuation
Share price (Rmb) 9.50 NPV per share (Rmb) 13.09 Share price discount to NPV 27.4% Years Ending 31 December, Rmbm 2013 2014 2015E 2016E 2017E 2018E 2019E 2020E 2021E 2022E 2023E 2024E 2025E
Valuation date 31-Dec-15 31-Dec-13 31-Dec-14 31-Dec-15 31-Dec-16 31-Dec-17 31-Dec-18 31-Dec-19 31-Dec-20 31-Dec-21 31-Dec-22 31-Dec-23 31-Dec-24 31-Dec-25
Revenue 51,343 53,971 51,338 53,707 55,205 57,464 58,227 58,554 59,558 59,768 59,848 59,929 60,011 Revenue Growth 11.1% 5.1% -4.9% 4.6% 2.8% 4.1% 1.3% 0.6% 1.7% 0.4% 0.1% 0.1% 0.1%
EBITDA 21,679 23,568 23,670 24,908 25,877 27,535 27,667 27,333 28,337 28,547 28,627 28,708 28,790 EBITDA Growth 7.7% 8.7% 0.4% 5.2% 3.9% 6.4% 0.5% -1.2% 3.7% 0.7% 0.3% 0.3% 0.3% EBITDA Margin 42.2% 43.7% 46.1% 46.4% 46.9% 47.9% 47.5% 46.7% 47.6% 47.8% 47.8% 47.9% 48.0%
Depreciation and Amortization (4,820) (4,931) (4,418) (4,239) (4,499) (4,758) (4,374) (4,479) (4,575) (4,822) (4,615) (4,842) (5,069)
EBIT 16,858 18,637 19,252 20,669 21,378 22,777 23,293 22,854 23,762 23,725 24,012 23,866 23,720 Imputed taxes on EBIT (3,541) (4,002) (4,134) (4,438) (4,591) (4,891) (5,002) (4,908) (5,103) (5,095) (5,156) (5,125) (5,094)
EBITDA 21,679 23,568 23,670 24,908 25,877 27,535 27,667 27,333 28,337 28,547 28,627 28,708 28,790 - Imputed taxes on EBIT (3,541) (4,002) (4,134) (4,438) (4,591) (4,891) (5,002) (4,908) (5,103) (5,095) (5,156) (5,125) (5,094) - + (Inc)/dec in working capital (811) 251 382 187 106 85 17 178 (36) 51 (58) 54 54 - Capital expenditures (4,738) (5,515) (4,500) (4,500) (4,000) (4,000) (4,000) (4,000) (3,800) (3,800) (3,500) (3,500) (3,500) + Proceeds from asset/share sales 19 50 50 50 50 50 50 50 50 50 50 50 50 Free Cash Flow 12,608 14,352 15,468 16,206 17,442 18,778 18,733 18,653 19,448 19,753 19,963 20,187 20,300 FCF growth 18.4% 13.8% 7.8% 4.8% 7.6% 7.7% -0.2% -0.4% 4.3% 1.6% 1.1% 1.1% 0.6%
WACC 11.2% 11.2% 11.2% 11.2% 11.2% 11.2% 11.2% 11.2% 11.2% 11.2% 11.2% 11.2% 11.2% 11.2%
NPV of Free Cash Flow 15,594 15,961 15,468 14,568 14,098 13,648 12,242 10,958 10,273 9,382 8,526 7,750 7,008
Calculation of terminal value Termnal growth 2.0% FCF at the beginning of terminal period 20,300 Terminal value 224,756 PV of terminal value 77,588
DCF (Rmbm) PV of FCF 108,454 Terminal value 77,588 Enterprise value 186,042 Net cash / (debt) 8,612 MVof minority interests - Equity value 194,654
No. of shares outstanding 14,867
Equity value per share (Rmb) 13.09
Source: Company Data, Morgan Stanley Research E = Morgan Stanley Research estimates
20 Daqin Railway Co. Ltd. | July 29, 2015 MORGAN STANLEY RESEARCH
Global Railroad Comparable Valuations
Exhibit 22: Global Railroad Comparable Valuations
Last px Target MS Mkt Cap Mkt Cap Share Price Perf. 52-wk FCF Yield (%) CURR 7/28/15 Price Rating (LC Mn) (USD Mn) 1-mo 3-mo 12-mo High Low 14 15E 16E Railway Operator Guangshen Railway Co. Ltd.* HKD 3.60 2.93 U 33,915 5,462 -19% -29% 19% 5.43 2.98 8.5 1.6 5.1 MTR Corp. Ltd.* HKD 34.65 33.00 E 200,655 25,887 -4% -10% 14% 40.00 29.85 na na na China Railway Tielong Container Logistics Co. Ltd. CNY 10.56 NA NC 13,786 2,220 -35% -24% 103% 20.30 5.14 na na na Daqin Railway Co. Ltd.* CNY 9.50 13.33 O 141,235 22,746 -24% -34% 32% 15.15 7.01 8.4 9.0 9.6 Tokyu Corp.* JPY 889.00 1,000.00 O 1,106,756 8,982 6% 9% 19% 915.00 631.00 na na na West Japan Railway Co.* JPY 8,776 8,300 E 1,699,081 13,789 12% 31% 83% 8,990 4,602 na na na Central Japan Railway Co.* JPY 22,060 19,000 U 4,341,414 35,233 -1% 0% 43% 24,800 13,320 na na na East Japan Railway Co.* JPY 11,775 13,900 O 4,625,774 37,541 6% 9% 38% 12,280 7,623 na na na National Express Group PLC* GBp 300.10 350.00 O 1,534 2,386 -4% 0% 15% 324.80 213.40 na na na Globaltrans Investment PLC* USD 3.51 6.50 E 37,694 628 -23% -30% -65% 10.24 3.45 na na na Norfolk Southern Corp.* USD 82.80 98.00 O 25,472 25,472 -8% -21% -23% 117.64 82.61 na na na CSX Corp.* USD 30.52 36.00 O 30,184 30,184 -10% -18% -2% 37.99 29.07 na na na Union Pacific Corp.* USD 92.39 105.00 O 80,860 80,860 -6% -14% -9% 124.50 91.23 na na na Mean 8.4 5.3 7.4 P/E (x) P/B (x) ROE(%) EV/EBITDA (x) Dividend Yield (%) 14 15E 16E 14 15E 16E 14 15E 16E 14 15E 16E 14 15E 16E Railway Operator Guangshen Railway Co. Ltd.* 32.3 28.9 28.5 0.8 0.8 0.7 2.5 2.6 2.6 11.2 13.2 12.7 1.7 1.4 1.4 MTR Corp. Ltd.* 16.0 20.1 20.4 1.1 1.2 1.2 7.6 6.2 6.0 10.8 13.7 13.8 3.3 3.1 3.1 Daqin Railway Co. Ltd.* 11.1 9.5 8.8 1.9 1.5 1.4 18.4 17.7 17.6 6.5 5.5 5.0 4.5 5.3 5.7 Tokyu Corp.* 19.2 24.6 20.5 1.8 2.0 1.8 10.1 8.5 9.4 11.8 13.3 12.5 1.1 1.0 1.0 West Japan Railway Co.* 17.9 19.0 17.2 1.5 1.9 1.8 8.6 11.1 11.3 7.7 8.3 7.9 2.0 1.5 1.7 Central Japan Railway Co.* 15.3 12.7 11.6 2.1 1.9 1.6 15.9 16.9 16.1 8.1 7.3 7.1 0.6 0.7 0.8 East Japan Railway Co.* 18.2 17.8 16.7 1.7 1.9 1.7 9.6 11.4 11.1 8.4 9.0 8.7 1.2 1.1 1.2 National Express Group PLC* 10.6 12.6 11.5 0.8 1.0 1.0 7.7 8.0 8.8 6.7 7.4 6.7 4.1 3.6 3.8 Globaltrans Investment PLC* 18.0 9.3 7.5 1.2 0.8 0.8 NA 9.4 10.6 4.7 3.7 3.1 - 5.4 6.7 Norfolk Southern Corp.* 16.6 15.1 13.5 2.8 2.0 1.9 18.3 13.2 14.5 9.0 8.1 7.4 2.0 2.9 2.4 CSX Corp.* 18.4 15.4 13.4 3.2 2.5 2.3 18.2 17.2 17.9 8.9 7.6 6.8 1.7 2.3 2.6 Union Pacific Corp.* 20.9 16.9 15.0 5.4 4.1 4.1 25.3 24.0 26.3 10.6 8.7 7.9 1.6 2.5 2.8 Mean 17.9 16.8 15.4 2.0 1.8 1.7 12.9 12.2 12.7 8.7 8.8 8.3 2.0 2.6 2.8
Source: * covered by Morgan Stanley Research NC = not covered, NA = not available. O = O verw eight, E – Equal-w eight, U = Underw eight E = Morgan Stanley Research estimates for covered stocks, Thomson Reuters estimates otherw ise Source: Morgan Stanley Research, Thomson Reuters
21 Daqin Railway Co. Ltd. | July 29, 2015 MORGAN STANLEY RESEARCH
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22 Daqin Railway Co. Ltd. | July 29, 2015 MORGAN STANLEY RESEARCH
COVERAGE UNIVERSE INVESTMENT BANKING CLIENTS (IBC) STOCK RATING CATEGORY COUNT % OF TOTAL COUNT % OF TOTAL % OF RATING IBC CATEGORY Overweight/Buy 1183 35% 315 43% 27% Equal-weight/Hold 1456 44% 336 45% 23% Not-Rated/Hold 93 3% 9 1% 10% Underweight/Sell 613 18% 79 11% 13% TOTAL 3,345 739
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INDUSTRY COVERAGE: Hong Kong/China Transportation & Infrastructure
COMPANY (TICKER) RATING (AS OF) PRICE* (07/28/2015)
Wong CFA, Victoria China COSCO (601919.SS) U (08/19/2014) Rmb10.18 China COSCO (1919.HK) U (08/19/2014) HK$4.03 China Merchants Energy Shipping Co. Ltd. (601872.SS) O (06/25/2015) Rmb7.88 China Shipping CL (2866.HK) E (07/09/2012) HK$2.51 China Shipping CL (601866.SS) U (08/19/2014) Rmb7.35 China Shipping Development (1138.HK) O (10/23/2013) HK$4.89 China Shipping Development (600026.SS) O (06/25/2015) Rmb9.89 Hopewell Highway Infrastructure (0737.HK) E (08/12/2014) HK$3.71 Jiangsu Expressway Company Limited (600377.SS) O (08/12/2014) Rmb8.00 Jiangsu Expressway Company Limited (0177.HK) O (08/12/2014) HK$9.71 Orient Overseas Int'l Limited (0316.HK) O (03/05/2014) HK$37.30 Pacific Basin Shipping (2343.HK) O (11/03/2014) HK$2.54 Zhejiang Expressway Company (0576.HK) U (07/16/2013) HK$9.05
Xu CFA, Edward H Air China Limited (0753.HK) E (12/16/2014) HK$8.11 Air China Limited (601111.SS) U (12/16/2014) Rmb14.50 Beijing Capital Int'l Airport (0694.HK) E (12/17/2013) HK$8.14 Cathay Pacific Airways (0293.HK) E (08/19/2013) HK$18.80 China Eastern Airlines (0670.HK) E (12/16/2014) HK$6.47 China Eastern Airlines (600115.SS) U (12/16/2014) Rmb12.49 China Merchants Hldg Intl (0144.HK) E (04/01/2015) HK$28.25 China Southern Airlines (1055.HK) O (12/16/2014) HK$7.73 China Southern Airlines (600029.SS) U (04/08/2015) Rmb13.54 CIMC (2039.HK) E (07/14/2014) HK$16.36 CIMC (000039.SZ) U (01/19/2015) Rmb23.69 COSCO Pacific (1199.HK) E (03/25/2015) HK$9.93 Daqin Railway Co. Ltd. (601006.SS) O (01/07/2010) Rmb10.12 Guangshen Railway (0525.HK) U (04/28/2014) HK$3.75 Guangshen Railway (601333.SS) U (07/18/2014) Rmb5.41 Hutchison Port Holdings Trust (HPHT.SI) E (03/05/2014) US$0.59 Kerry Logistics Network (0636.HK) O (03/27/2015) HK$11.60 Shanghai International Airport (600009.SS) U (06/24/2015) Rmb28.50 Shenzhen International Holdings (0152.HK) O (05/27/2014) HK$13.32 Sichuan Haite High-Tech (002023.SZ) O (06/16/2015) Rmb21.62 Sinotrans Air Transportation Development (600270.SS) E (05/18/2015) Rmb27.81 Sinotrans Limited (0598.HK) O (05/27/2014) HK$4.92 SITC International Holdings Company (1308.HK) O (08/08/2011) HK$4.71 Spring Airlines (601021.SS) O (02/24/2015) Rmb110.12
Stock Ratings are subject to change. Please see latest research for each company. * Historical prices are not split adjusted.
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