Asia Pacific Equity Research 30 October 2016 Overweight CRRC Corp -H 1766.HK, 1766 HK Outlook bullish. Weak Q3 and delayed orders factored Price: HK$7.15 ▼ Price Target: HK$12.50 in. Maintain OW Previous: HK$13.00 3Q16 result expectedly weak; guidance turned positive with MU China demand outlook raised. CRRC reported 3Q NPAT of Rmb2.7B, -16% Infrastructure, Industrials & Y/Y as revenue fell 4% Y/Y while GPM slipped 1.1ppts Y/Y. These Transport results were largely expected in light of CRC’s muted procurement Karen Li, CFA AC YTD. However, we observed that guidance was noticeably more bullish (852) 2800-8589 (inside for takeaways from the briefing) despite the near-term earnings [email protected] Bloomberg JPMA KLI <GO> pressure in 4Q16. Mgmt expects this year's pent-up orders to be released J.P. Morgan Securities (Asia Pacific) Limited soon with CRC's leadership transition completed, while highlighting the robust MU demand in coming years driven by new product sales, rising Price Performance aftersales services, and increasing MU density. We remain positive on 10.5 the demand outlook for rolling stock in China, recommending switching 9.5 HK$ to late cycle railway capex plays over E&C contractors. Our new Dec-17 8.5 PT is HK$12.5 for CRRC-H; maintain OW. 7.5 6.5 CRC leadership transition completed; pace of procurement to Oct-15 Jan-16 Apr-16 Jul-16 Oct-16 1766.HK share price (HK$) accelerate into year-end. Mgmt was optimistic that this year’s long- HSCI (rebased) awaited orders will be released soon, highlighting CRC's new chief Mr. YTD 1m 3m 12m LU Dongfu had reiterated this year's rail capex target. On the locomotive Abs -25.4% 0.1% -1.2% -29.5% Rel -29.2% 1.3% -6.4% -28.2% front, underlying freight rail demand rebounded notably from the recent trough, which should drive resumption of the replacement demand as well as the ongoing substitution of diesel engine locomotives. However, we note that CRRC may not have enough time to deliver this year’s upcoming new orders before year-end, hence a 23% earnings cut for FY16E (-8% for FY17E). Guidance for normalized MU demand during 13th FYP raised to 400 trainsets p.a. Prior guidance, given at 1H briefing, expected normalized annual MU demand of 300 trainsets during 13th FYP. Increased guidance is a key positive, in our view, given exceptionally low procurement this year. Additionally, mgmt expects MU density for existing HSR lines to rise, noting CRC’s plans to add late night train services. China’s standard MUs with designed speed of 350km/hr have completed trial runs, hence could soon be commercially launched. CRRC Corp - H (Reuters: 1766.HK, Bloomberg: 1766 HK) Rmb in mn, year-end Dec FY14A FY15A FY16E FY17E FY18E Company Data Total Revenue (Rmb mn) 221,977 241,913 220,869 259,046 279,895 Shares O/S (mn) 27,289 Net Profit (Rmb mn) 10,815 11,818 10,235 14,526 17,016 Market Cap (HK$ mn) 195,115 EPS (Rmb) 0.41 0.43 0.38 0.53 0.62 Market Cap ($ mn) 25,160 Revenue growth (%) 12.9% 9.0% (8.7%) 17.3% 8.0% Price (HK$) 7.15 EPS growth (%) 24.0% 5.9% (13.4%) 41.9% 17.1% Date Of Price 27 Oct 16 ROE 13.2% 12.7% 10.2% 13.4% 14.1% 3M - Avg daily vol (mn) 18.73 P/E (x) 15.3 14.4 16.7 11.7 10.0 3M - Avg daily val (HK$ mn) 134.10 P/BV (x) 1.9 1.8 1.7 1.5 1.3 3M - Avg daily val ($ mn) 17.3 EV/EBITDA (x) 9.9 9.5 9.8 7.4 6.2 HSCI 3136.08 Source: Company data, Bloomberg, J.P. Morgan estimates. Price Target End Date 31-Dec-17 See page 9 for analyst certification and important disclosures, including non-US analyst disclosures. J.P. Morgan does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. www.jpmorganmarkets.com Karen Li, CFA Asia Pacific Equity Research (852) 2800-8589 30 October 2016 [email protected] Key catalysts for the stock price: Upside risks to our view: Downside risks to our view: • Potential raise in this year's railway capex • Stronger-than-expected MU demand driven by • Unexpected changes in government’s investment in target faster-than-expected growth for HSR ridership railway development • New order awarding for rolling stock and better-than-expected railway network effect • Major fluctuations in raw material costs biddings for 2016 and 2017 • Better-than-expected overseas expansion • Potential capacity constraints. • Better-than-expected new business development Key financial metrics FY15A FY16E FY17E FY18E Valuation and price target basis Revenues (LC) 241,913 220,869 259,046 279,895 Our Dec-17 H-share PT of HK$12.5 is derived based on DCF valuation Revenue growth (%) 9% -9% 17% 8% methodology. Our PT corresponds to a P/E of 20.5x/17.5x and a P/B of EBITDA (LC) 23,506 22,707 28,410 31,812 2.6x/2.3x on FY17/FY18E. EBITDA margin (%) 10% 10% 11% 11% Tax rate (%) 17% 18% 15% 15% Net profit (LC) 11,818 10,235 14,526 17,016 EPS (LC) 0.43 0.38 0.53 0.62 EPS growth (%) 9% -13% 42% 17% Historical P/E valuation chart DPS (LC) 0.15 0.11 0.16 0.19 40.0 BVPS (LC) 3.55 3.78 4.20 4.66 35.0 Operating cash flow (LC mn) 14,982 19,861 24,076 28,438 30.0 Free cash flow (LC mn) 6,866 12,642 17,544 21,465 25.0 21.6x Interest cover (X) 26.3 21.3 42.5 213.2 20.0 16.9x Net margin (%) 4.9% 4.6% 5.6% 6.1% 15.0 Sales/assets (X) 0.79 0.72 0.83 0.83 10.0 Debt/equity (%) 23% 19% 6% 5% 12.2x 5.0 Net debt/equity (%) -11% -13% -22% -30% 0.0 ROE (%) 12.7% 10.2% 13.4% 14.1% Key model assumptions FY15A FY16E FY17E FY18E Revenue growth (%) 9.0% -8.7% 17.3% 8.0% Gross profit margin (%) 20.2% 20.0% 20.9% 21.2% LT historical P/E Avg P/E LT historical P/E -1 STDEV LT historical P/E +1 STDEV 1yr fwd P/E (x) Source: Company and J.P. Morgan estimates. Source: Bloomberg, Company and J.P. Morgan estimates. Sensitivity analysis EBITDA EPS JPMe vs. consensus, change in estimates Sensitivity to FY16E FY17E FY16E FY17E EPS FY16E FY17E 1ppt chg in revenue growth 1% 1% 2% 2% JPMe old 0.50 0.59 1ppt chg in GPM 12% 11% 18% 15% JPMe new 0.38 0.53 % chg -23% -8% Consensus 0.45 0.49 Source: J.P. Morgan estimates. Source: Bloomberg, J.P. Morgan estimates. Comparative metrics CMP Mkt Cap P/E EV/EBITDA P/BV YTD LC $Mn FY16E FY17E FY16E FY17E FY16E FY17E Stock perf. CRRC-H 7.11 35,849 14.4 16.6 12.1 12.5 1.8 1.6 -25.8 Zhuzhou CSR 37.65 5,708 13.2 11.0 9.7 8.4 2.4 2.1 -16.4 Hollysys Automation 19.9 1,189 9.2 9.1 8.8 8.8 1.5 1.3 -10.4 Bombardier 1.3845 3,166 -8.2 -30.1 16.6 12.4 -0.6 -0.7 44.9 Kawasaki Heavy Industry 310 4,916 15.6 12.2 8.4 7.5 1.1 1.1 -31.4 Alstom 24.26 5,816 22.3 15.8 10.9 9.5 1.5 1.4 -13.9 Source: Bloomberg, J.P. Morgan estimates. Prices are as of 10/29/2016 2 Karen Li, CFA Asia Pacific Equity Research (852) 2800-8589 30 October 2016 [email protected] Key takeaways from analyst briefing call Backlog for locomotives and MUs light given delayed procurement this year Backlog on hand, totaling Rmb203.8B, includes RTVs (namely subway trains, Rmb106.9B), MUs (Rmb48.5B), locomotives (Rmb20.5B) and new businesses (Rmb15.6B). RTVs formed half of the backlog in light of CRC's exceptionally light procurement YTD. For locomotives, the 195 units of locomotives procured by CRC earlier this year have all been delivered by end-3Q, and hence the orders on hand primarily consist of South African orders. For MUs, backlog of 190+ trainsets consist of 60+ trainsets held by BST. 13th FYP MU demand to remain robust with total demand guidance raised Guidance for normalized MU demand during 13th FYP was raised to 400 trainsets (from the prior 300 trainsets). Mgmt explained that the prior guidance, given at 1H briefing, represents CRC’s expected normalized demand of 300 trainsets per year during the 13th FYP but did not consider additional demand from inter-city railways (which would not go through centralized procurement/bidding). The latest guidance up to 2020 is a key positive, in our view, in light of the exceptionally low procurement in this year. Furthermore, mgmt expects MU density for the existing HSR lines to rise, noting CRC plans to add overnight train services on major lines.