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. Zhuzhou CSR Times Electric (3898 HK) support from the China government. also like CSR due to its high backlog coverage. These companies should all Rating Buy Target 58.00 We forecast total railway FAI to rise benefit from this merger through reduced costs and competition. Upside 29.9% by 20% YoY to CNY800bn for 2014; 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