Asian Insights SparX One Belt One Road Infrastructure Sector Refer to important disclosures at the end of this report DBS Group Research . Equity 24 Jul 2017 OBOR: moving faster than expected HSI: 26,706 ANALYST • Our analysis shows that market has yet to price in the potential investment spending from OBOR initiative; total Rachel MIU +852 2863 8843 [email protected] OBOR surged sharply in 2016 and China has a large share Chong Tjen-San, CFA +60 3 26043972 • One of the key growth drivers will be from ASEAN as Chinese contractors expand their presence in the region [email protected] • CCCC (1800 HK) best for OBOR exposure; CRCC (1186 HK) Chris Leung +852 3668 5694 ** still see mid-term upside potential [email protected] ** contributed to macro inputs only Implementation of OBOR projects is accelerating; Chinese companies are securing more projects. China is stepping up its project-driven growth model to countries interested in the One Recommendation & valuation Belt, One Road (OBOR) initiative. The OBOR strategy could pave Company Price Target Recom Mkt FY18F the way for much higher investments in the future, and provide Price Cap PE enormous opportunity for the Chinese contractors. They are Local$ Local$ US$m x participating in several large-scale infrastructure projects in six major regions, with huge interests in the China-Pakistan Economic Infrastructure construction Corridor (CPEC) development. The Chinese contractors are now CCC-H (1800 HK) HK$ 10.88 12.90 BUY 36,292 7.1 targeting at ASEAN, the next up and coming region. We estimate CCC-A (601800 CH) RMB 17.31 18.10 HOLD 36,292 13.0 the transport related investment could be much higher than the CRCC-H (1186 HK) HK$ 10.80 12.90 BUY 25,587 7.3 initial phase, exceeding US$200 billion over a 5-year period in CRCC-A (601186 CH) RMB 13.33 12.50 HOLD 25,587 10.5 ASEAN. Through OBOR, it not only creates demand for China- Gamuda (GAM MK) MYR 5.26 6.70 BUY 3,000 18.9 made goods (especially train equipment), but also mops up some Sunway Construction MYR 2.04 2.60 BUY 615 14.8 excess capacity and promotes the use of RMB in settlements. (SCGB MK) Time to take a relook at Chinese contractors as they have Railway equipment won huge OBOR projects. In 2016, Chinese contractors signed CRRC-H (1766 HK) HK$ 7.02 8.40 BUY 40,725 12.3 US$126bn of infrastructure contracts in countries along OBOR, CRRC-A (601766 CH) RMB 10.21 11.10 HOLD 40,725 20.6 36% higher than 2015. China’s share of new contracts along the OBOR route was about 52% in 2016. To date, Chinese Source: Thomson Reuters, DBS Vickers contractors have made good progress in Malaysia, winning some US$15 billion worth of new engineering, procurement, and construction (EPC) rail projects. Chinese contractors have an edge, thanks to their access to funding, cost competitiveness, and fast turnaround. China Communications Construction Co (CCCC) stands to benefit the most as it has the highest exposure to overseas OBOR-related projects. China Railway Construction Corporation (CRCC) is our No 2 pick as it is quickly catching up, with overseas new projects surging 25% year-on-year in 2016. ASIAN INSIGHTS VICKERS SECURITIES ed-GT/ sa- CW Asian Insights SparX One Belt One Road Infrastructure Sector The DBS Asian Insights SparX report is a deep dive look into thematic angles impacting the longer-term investment thesis for a sector, country or the region. We view this as an ongoing conversation rather than a one-off treatise on the topic, and invite feedback from our readers, and in particular welcome follow on questions worthy of closer examination. Table of Contents Executive Summary 3 Chinese contractors gaining traction in Malaysia under the OBOR initiative 4 Rising infrastructure spending in Asia 4 OBOR opportunities for Chinese contractors 6 Stock pick 9 One Belt, One Road (OBOR) 13 Inception of OBOR 13 Important implications from latest OBOR conference 14 Successful implementation of China-Pakistan Economic Corridor (CPEC) 15 Iran-Pakistan Pipeline (Peace pipeline project) 17 Pan-Asia Railway Network 18 China-Indochina Peninsula Economic Corridor 20 Benefits of OBOR 21 OBOR to drive trade growth 21 The potential exporting of high-end transportation equipment 21 Reform of major industries (and SOEs) 21 Globalisation strategy 22 Project funding avenues are widening 23 The Asian Infrastructure Investment Bank (AIIB) 23 Silk Road Fund (SRF) 24 Other Financing Vehicles 24 Drivers of infrastructure needs 25 Urbanisation drive 25 Market liberalisation and foreign trade development 25 Lack of domestic capital 25 Underdeveloped infrastructure 25 Risks of OBOR projects 26 Stock Profiles 28 China Communications Construction (1800 HK/601800 CH) 28 China Railway Construction (1186 HK/601186 CH) 35 CRRC Corporation (1766 HK/601766 CH) 42 Gamuda 49 Sunway 61 Appendix 69 Note: Prices used as of 21 Jul 2017 ASIAN INSIGHTS VICKERS SECURITIES Page 2 Asian Insights SparX One Belt One Road Infrastructure Sector Executive Summary The bigger picture. The One Belt, One Road (OBOR) initiative is Infrastructure spending a new platform for China to develop its a novel concept, integrating the goals of foreign policies with globalisation strategy. China is developing its own growth economic policies. The programme helps Chinese state-owned model premised on “statecraft”, and OBOR plays a dominant enterprises (SOEs) to go global and, when combined with the role in this agenda. The implications are profound as backing of state credit, also advances foreign policy objectives “centralisation of control” is required under this strategy. by investing in infrastructure along the ancient Silk Road. Through OBOR, China is driving Globalization V2.0. Infrastructure spending along the Silk Road is the new platform. Historically, China has ridden on foreign developments to Investment flow will likely be one-way in the early stages. Thus, strengthen its domestic reform agenda if the deals favour China must score a success as soon as possible to sustain the Beijing. China’s accession to the World Trade Organization novel agenda. (WTO) in early 2000 was a prime example, as evidenced by the sharp rise in foreign reserves from only US$166 billion in 2000 Equities should catch up. It is time for equities to catch up with to US$1,946 billion in 2008. Authorities just need to the big plans. A solid foundation has been laid and Chinese understand the rule-based trade system. The next step is to contractors are ready to take off. The OBOR is a conducive reap economic benefits from it. platform for the Chinese contractors to export their expertise in undertaking mega infrastructure projects at competitive prices Unlike the WTO deal, the OBOR is much more complicated as and quick turnaround. In 2016, China signed US$126 billion it involves facilitating long-term investment in numerous worth of overseas projects with countries along the OBOR, countries with vast cultural and economic differences, beyond 36% higher than in 2015. Chinese contractors are actively any pragmatic political aspirations that Beijing may have. bidding for many infrastructure projects in Asia and their China has had to design a rule-based system to govern OBOR- overwhelming success in Malaysia stands out. 2017 is expected related institutions to safeguard project longevity and to be another exciting year for Chinese contractors, and we operational stability. This is a tremendous task, given China’s estimate the value of overseas projects to grow by 10-15%. lack of experience in managing international institutions of such scale. Our top pick is China Communications Construction Co or CCCC (1800 HK) because this company has the highest Enormous contract opportunity in Asia, much higher than exposure to overseas OBOR-related projects. Its current expected. Based on our analysis, we believe the potential valuation is attractive, given decent mid-teens profit growth. At infrastructure spending is huge and could exceed expectation. present, overseas backlog accounts for some 50% of total The cost of developing infrastructure in Asia runs into the outstanding projects. Also, the company is balancing its billions – infrastructure along the China-Pakistan Economic growth and financial position (given its high net gearing ratio). Corridor (CPEC) is estimated to cost some US$40 billion and This is crucial because the growing number of new contracts that in ASEAN is estimated at US$77 billion. However, this is would translate to higher working capital needs, hence just the initial batch of major infrastructure projects being creating a potential drag on its balance sheet. identified under the OBOR initiative. As history shows, the amount of transport infrastructure investment will rise in the Our No 2 pick is CRCC as it is quickly catching up, with long-term to match with the economic development. Hence overseas new projects surging 25% year-on-year in 2016. It we estimate the total transport infrastructure investment to cost has the best balance sheet (lowest net gearing ratio in the more than US$200 billion over a five-year period, more than sector) and is expected to achieve low double-digit earnings double the current batch of transport infrastructure projects growth from 2016-2018. under development in the ASEAN region. Many of these projects have Chinese participation. China-led Asian Infrastructure Train equipment is another important theme. We like CRRC Investment Bank (AIIB) has approved US$2.8 billion worth of (1766 HK) for its mid- to long-term prospect. Domestic railway OBOR-related projects in Asia (with another US$2 billion in the investments (national and metro) as well as its export potential pipeline) and the Chinese government has pledged more are earnings catalysts for CRRC.