MIDAS HOLDINGS – BUYING INTO CHINA’S FAST-GROWING RAILWAY SECTOR Price: S$1.01 (Target price S$1.20) October 11, 2010 [email protected] Country CHINA FY Mo. S$ mn 2008A 2009A 2010E 2011E Region Asia Revenues 138 150 194 275 Ticker (Reuters/ Bloomberg) MIDA SP EBITDA 46.2 54.4 57.5 83.5 Sector Cyclical EPS 0.03 0.04 0.05 0.07 Industry Transport CFPS 0.04 0.05 0.06 0.08 Mkt. Cap Large FV/EBITDA 90.4x 85.5x 58.9x 50.2x Investment Style Growth P/E 27.9x 24.3x 22.0x 14.7x Up/ Downside (to target price) 19% Price Performance 2007 2008 2009 YTD Report Type Initiation Absolute 16.9% -68.1% 89.7% 9.8% Recommendation BUY Relative 0.3% -18.7% 26.2% 3.3% 52-week Range 0.79-1.16 2 Year Price Chart Dividend/Yield 0.7 % Market Cap (US$ mn) 732 Avg Daily Volume (‘000) 6,000 Est. 5-year EPS Growth 18 % Chen & Patrick/ Controlling Shareholder/% 26% L-T Debt/Capital 5 % ROE (2010 E) 12 % Current Book Value/ Share 0.35 Price/Book 2.9 x Source: Company, Riedel Research Group Inc. Relative price performance shown relative to STI RMB/S$ = 5.0 CFPS = Net profit+depreciation per share • We recently visited Midas’ aluminium alloy extrusion plant in Jilin and the metro-train manufacturing plant in Nanjing belonging to its 32.5%-owned joint venture Nanjing SR Puzhen Rail Transport Co’s (NPRT). We came away with very positive view about the group’s growth prospects. • We are also very positive of China’s railway sector in particular the high-speed rail (HSR) and metro rail segment, which the China authorities are giving priority in their development program, given that China is anxious to relieve the bottlenecks in road transport and to move towards cutting carbon emissions. The 12th Five-Year Plan 2011-15, due to be released early next year, should give a further boost to the sector. • Midas is expanding its plant capacity for production of aluminium extrusion profiles, which are mainly supplied to manufacturers of high-speed and metro train cars. To keep ahead of its competitors, it is moving downstream to fabrication of train car frames. When the expansion is completed in MIDAS HOLDINGS – BUYING INTO CHINA’S FAST-GROWING RAILWAY SECTOR Page 1 of 12 www.riedelresearch.com 1Q2011, Midas’ earnings will grow strongly by 50% in 2011 and 18% in 2012. • The jewel in Midas is probably the 32.5% stake in NPRT, which holds one of the five licenses in China to manufacture HSR or metro cars. NPRT is licensed to produce only metro cars. The associate’s profit contribution has been rising significantly since NPRT’s inception in 2007. • The key risks are likely to come from the increase in industry capacity and competition from new entrants into the industry. • Midas is currently trading at slightly above its peer PE average. The rise of 11% in price over the past month probably reflected the proposal of dual listing in Hong Kong. We recommend a BUY rating for the stock based on the very positive outlook of the industry and the limited opportunities to invest directly in a train builder. Looking at Midas’ 2012 earnings, we have a price target of $1.20, 19% upside. Industry Highlights Rail Development and Positive Implications for Midas Rail transport development has gained high priority in the Chinese government’s development strategy over the past decade. While the government aims to extend the rail networks, it is particularly focused on ramping up the development of high-speed rail (HSR) transport on a national scale, and the development of urban rail transport and inter-city HSR rail transport systems. China’s high-speed trains travel at 350km/h, which is faster than their earlier definition of 250km/h. The train cars that run on HSR railways in China typically are made of material comprising aluminium alloy. Production of aluminium alloy extrusion products for the body frames of HSR and metro train cars is the currently the main business of Midas Holdings. Size of National Rail Network By 2009, China already had 86,000 km of operating railway mileage, making it second longest railway network after the United States, which has 260,000 km. The network should reach 90,000 km of operating railway mileage by the end of this year. China is planning to extend its rail network to reach 120,000 km by 2020. China is upgrading some existing conventional rail lines to accommodate HSR trains and constructing new lines dedicated specially to run HSR trains. According to the Ministry of Railways’ long-term plan, it is building a HSR network consisting of four east-west lines and four north-south lines. The north-south lines include the 1,318 km long Beijing-Shanghai line, which will be ready in 2011. China has planned to expand the HSR network from the current 7,000 km to 13,000 km by 2012 and at least 25,000 km by 2020. Huge Potential for Growth in Metro Lines Even more phenomenal is the recent growth of China’s urban rail transit system. China has issued directives to give priority to the development of urban rail transit in order to improve efficiency of transport resources and relieve urban road traffic jam. From 10 cities with 31 metro lines and operating mileage of over 800 km in 2008, the number has increased to 15 with 55 metro lines and operating mileage of 1,500 km by the end of this year. Currently, the cities which MIDAS HOLDINGS – BUYING INTO CHINA’S FAST-GROWING RAILWAY SECTOR Page 2 of 12 www.riedelresearch.com already have metro lines are Beijing, Shanghai, Tianjin, Guangzhou, Shenzhen, Wuhan, Nanjing, Chongqing, Changchun, Harbin, Shenyang, Hangzhou, Xian, Chengdu and Suzhou. Another 8 cities are preparing to build their metro lines: Ningbo, Wuxi, Changsha, Zhengzhou, Dalian, Nanchang, Qingdao, and Fuzhou. They will have an aggregate of 1,000-1,500 km of metro lines. Cities that qualify for metro construction in China must satisfy the criteria of having population of over 3m, GDP exceeding Rmb100 bn and annual fiscal revenue exceeding Rmb10 bn. By the end of 2008, already 50-60 cities met the criteria. According to the 17-City Urban Rail Transit Scheme, the Chinese government had approved the rail transport plans in 17 cities, which are planning to construct 65 metro lines by 2015 with the total lengths of 1,856 km and the total investments exceeding Rmb675 bn (US$96.5 bn). These investments will raise total urban rail transit lines to 3,400 km. Inter-City HSR Lines Another focus of the authorities is the building of inter-city HSR system to provide an alternative to the domestic flight network. A number of new HSR railways are being built and will be finished in the coming few years, of which notable examples are the completed Beijing-Tianjin line (117 km, completed in 2008) and the recently completed Shanghai-Nanjing line (301 km completed in July 2010). Some 4,000 km of inter-city HSR lines are in various stages of planning and construction. Big Budget for Rail Infrastructure For the 11th Five-Year Plan in 2006-2010, China invested heavily in railway networks, spending about Rmb1.25 bn. In the next decade, China had initially planned to increase the network from 90,000 km to 110,000 km by 2020. But, as a result of the 2008 global financial crisis, it brought its 2020 deadline forward by eight years to 2012 as part of its economic stimulus package. By 2020, the railway network is expected to increase further to 120,000 km and China plans to build high- speed railways covering 80% of the current domestic flight network and 70% of the country’s key cities according to the Ministry of Railways. With China’s focus on the environment and choice of transportation modes with lower emission, we expect the forthcoming 12th Five-Year Plan in 2011-2015 to benefit the railway sector and particularly the HSR segment. The outline for the 12th Five-Year Plan in 2011-2015, which should be finalized earlier next year, already indicates the investment in urban rail transport alone will exceed Rmb700 bn during the plan. Duopoly of Infrastructure Builders The two listed Chinese companies, China Railway Group (390 HK) and China Railway Construction Group (1186 HK), form a duopoly in the railway infrastructure market with a combined 85% share of the market in China. The third player is China Communications Construction (1800 HK). Train Car Manufacturers are Direct Beneficiaries Train car or rolling stock manufacturers are direct beneficiaries of the rapid expansion in rail network. In particular, the increased HSR and metro line network entails an increase in demand for train cars. China’s Ministry of Railways has projected 8,880 train cars to run on 13,000 km of HSR by 2012. It has so far awarded contracts for more than 5,700 train cars and has committed to build more than 10,000 train cars in 2009-10 to cater to the needs of a larger rail network. The value of each locally-made train car is about Rmb5-7 mn compared with Rmb12 mn for imported ones. More contracts are expected to be awarded. The potential is tremendous for train car manufacturers and their parts supplies. Assuming that HSR density (train cars per km) remains unchanged at 0.7 (which is very low by international standard as developed countries have average of 1.8), come 2020 when 25,000 km of HSR network is completed, there should be a need for 17,000 train cars.