CHINA China CNR Corp The other twin brother We initiate coverage on China CNR with an Outperform rating. China CNR is one of the duopolies in China’s railway equipment market. Our target price is HK$6.95, based on a target PER multiple of 11.4x 2015E PER, translating into a 0.62x PEG and with 36.0% upside potential. We believe the company will benefit from robust railway investment over the next 5 years and demand growth on MUs and locomotives will be steady in the long term, driven by an increase in density. In addition, the company put effort in R&D to localise key components 6199 HK Outperform production, which will help to expand margins. Beneficiary of railway reforms and shifting industry focus Price (at 07:59, 24 Jun 2014 GMT) HK$5.11 China accelerated railway network modernisation and expansion from 2008 to Valuation HK$ 6.95 2013, with a record level of new railway lines and high-speed railway (HSR) lines - PER to be launched into operation in the next few years. From 2014 onwards, the 12-month target HK$ 6.95 Upside/Downside % +36.0 railway industry’s focus is shifting to improving return on assets and generating 12-month TSR % +38.8 profits to repay the incurred debt. We believe China will continue to deepen its Volatility Index Low railway reform, increasing railways’ competitiveness in the transportation market, GICS sector Capital Goods and continue to increase HSR operating density which will help alleviate capacity Market cap HK$m 67,389 bottleneck issues in the railway network. We expect an additional 30% to 50% of Market cap US$m 8,694 railway freight capacity will be freed up when the major HSR network fully opens Free float % 100 by the end of 2015. Train equipment producers are the key beneficiaries. 30-day avg turnover US$m 13.5 Number shares on issue m 13,188 Favourable industry landscape The entry barrier to China’s railway equipment sector is high. The government Investment fundamentals Year end 31 Dec 2013A 2014E 2015E 2016E has launched localisation initiatives since the early 2000s, and foreign Revenue bn 96.8 107.6 120.9 133.3 companies had to work with local partners to develop products and supply to the EBIT bn 6.0 7.2 8.3 9.4 Ministry of Railways. The localisation policies helped Chinese producers to EBIT growth % 20.1 19.5 15.7 12.5 Reported profit bn 4.1 5.1 6.0 6.8 rapidly develop their own in-house R&D capabilities, manufacturing and supply- Adjusted profit bn 4.1 5.1 6.0 6.8 chain scale. In the HSR railway and locomotive equipment space, China EPS rep Rmb 0.40 0.45 0.49 0.55 EPS rep growth % 17.3 12.5 8.9 12.8 achieved its 80% localisation target rate by the end of 2013. EPS adj Rmb 0.40 0.45 0.49 0.55 EPS adj growth % 17.6 12.3 9.1 12.8 Various drivers to support robust earnings growth PER rep x 10.3 9.1 8.4 7.4 PER adj x 10.3 9.1 8.4 7.4 We forecast CNR’s earnings will see an 18% CAGR from 2014 to 2016. We Total DPS Rmb 0.10 0.11 0.12 0.14 forecast its earnings will grow strongly in 2014, at 23.0% YoY, following a strong Total div yield % 2.4 2.7 3.0 3.4 ROA % 5.3 5.6 5.7 5.9 tender recovery and high-end train order gains from CRC in 3Q2013. We ROE % 11.4 11.6 11.6 12.0 forecast its earnings will grow at 18.3% YoY and 12.8% YoY in 2015 and 2016, EV/EBITDA x 6.6 6.6 5.8 5.2 Net debt/equity % 34.8 14.0 12.6 10.0 respectively, driven by robust railway and urban transit equipment demand in P/BV x 1.1 1.0 0.9 0.9 China and limited competition in the domestic market. CNR is also rapidly Source: FactSet, Macquarie Research, June 2014 expanding into international markets while its product offerings and technology (all figures in Rmb unless noted, TP in HKD) capabilities are exceeding those of its global peers. The company is also improving key component production to lift margins and leverage its technology platform to expand into other new product areas. Valuation and risks We use a PER valuation methodology and our target price is based on 11.4x Analyst(s) 2015E PER. Our CNR PER target multiple is at a 19% discount to CSR’s Saiyi He, CFA target multiple of 14.1x 2015E PER, to reflect the 24% lower ROE CNR has +852 3922 3585 [email protected] Kelly Zou over CSR. The stock currently trades at 8.4x 2015E PER; it also offers an +86 21 2412 9068 [email protected] attractive discount to its global peer group, weighted against growth prospects. Key risks: 1) CRC tender could be slower than expected; 2) CNR might lose 26 June 2014 market share to its competitor; 3) CRC might tender lower grade products Macquarie Capital Securities Limited which would reduce margins. Please refer to page 50 for important disclosures and analyst certification, or on our website www.macquarie.com/research/disclosures. Macquarie Research China CNR Corp Inside China CNR Corp The other twin brother 3 Company profile Valuation, recommendation, risks 4 . CNR together with CSR dominates the domestic rolling stock market. The company offers a full range of rolling stock products and services, including Business segment overview 13 locomotives, passenger carriages, freight wagons, MUs and RTVs, etc. Other Industry demand outlook 27 than the rolling stock business, it has also diversified its business into general Financial statement analysis 39 mechanical and electric products, modern services and emerging industries. Risk analysis 42 . The history of CNR can be traced back to 1949 when the Factory Affairs Appendices 47 Bureau of the Ministry of Railways was established. Later in 1986, the previous MOR restructured this entity into MOR locomotive and Rolling Stock Industrial Corporation, from which China National Railways Locomotive and Rolling Stock Industrial Corporation was formed in 1989. Fig 1 6199 HK rel HSI performance . China National Railways Locomotive and Rolling Stock Industrial Corporation were split into CNRG and CSRG in 2002. CNRG is a state-owned enterprise. CNR was established as a joint stock limited company in 2008. CNRG, as its parent company, injected its core businesses and assets into CNR. CNR was listed on Shanghai Stock Exchange in 2009 and HKEX on 22 May 2014. The company’s auditor is KPMG Huazhen. According to SCI Verkehr, CNR is the world’s largest manufacturer of electric locomotives and metro cars, as well as the world’s 2nd largest and China’s largest manufacturer of freight wagons in terms of aggregate number of units Source: FactSet, Macquarie Research, June 2014 delivered between 2008 and 2012 in each product category. It is the largest (all figures in Rmb unless noted, TP in HKD) rolling stock manufacturer in China in terms of revenue in 2012. According to CRC, CNR won the bids for 66.0%, 57.3% and 47.8% of the total number of the MUs with a maximum operating speed over 300km/h, locomotives and freight wagons that CRC purchased in 2013, respectively. The company is also engaged in the manufacturing of mechanical and electrical products and clean energy and environmental protection equipment, trading of raw materials, finance leasing of rolling stock and machines and equipment, and project management contracting services for urban rail and other related projects with the aim of providing future cities with systematic solutions. CNR currently exports its products to nearly 80 countries and regions in Oceania, Southeast Asia, Latin America, Central Asia, South Asia, Middle East, Africa and North America. Its overseas revenue contribution generated from export of railway equipments and various other products rose from 7% in 2011 to over 10% in 2012. The overseas business has been growing fast at 23.5% CAGR over 2006-2013. Fig 2 CNR business profile based on 2013 results – revenue breakdown Emerging industry 4.3% Locomotive 16.3% Modern service 23.6% Passenger carriage 8.3% Mechanical and electric product 1.9% Railway engineering Freight wagon machinery and 13.7% equipment 1.3% Rapid transit vehicle 6.0% MU 24.7% Source: Company data, Macquarie Research, June 2014 26 June 2014 2 Macquarie Research China CNR Corp The other twin brother CNR is one of the duopolies in China’s Bright growth prospect for the China rolling stock industry rolling stock industry We initiate on China CNR (6199 HK) with an Outperform rating. The company is one of the duopolies in China’s railway equipment market. We believe the company is a key beneficiary from the robust railway equipment and urban transit network investment in China over the We expect the next five years. railway equipment producers are the In China the railway network upgrade and expansion has happened since 2008, a record late-cycle level of new railway lines and high-speed railway (HSR) lines will be launched into operation beneficiaries from in the next few years. From 2014 onwards, the railway industry’s focus is shifting to improving China’s railway return on assets and generating profits to repay the incurred debt. infrastructure investment Fig 3 China railway industry investment forecasts 2008 2009 2010 2011 2012 2013 2014E 2015E Total Railway FAI (Rmb 416.8 704.5 842.7 594.7 657.7 663.8 800.0 760.0 bn) yoy growth 61% 69% 20% -29% 11% 1% 21% -5% - Railway construction 337.6 600.4 707.5 460.1 521.5 550.0 655.0 600.0 yoy growth 89% 78% 18% -35% 13% 5% 19% -8% - Railway refurbishment 22.7 25.4 28.5 30.6 31.8 27.0 25.0 25.0 yoy growth 3% 12% 13% 7% 4% -15% -7% 0% - Locomotives & trains 56.6 78.7 106.7 104.0 104.3 86.8 120.0 135.0 yoy growth -1% 39% 35% -2% 0% -17% 38% 13% Source: CRC, Macquarie Research, June 2014 We believe China will continue to deepen its railway reform, increasing railways’ competitiveness in the transportation market, and continue to increase HSR’s market share in passenger transportation which will help alleviate capacity bottleneck issues in the railway network.