China Railway Construction

On the right track
Ride the Chinese infrastructure spending boom
We initiate coverage on China Railway Construction Corporation (CRCC) with an
Outperform recommendation and target price of HK$14.50/sh based on a sumof-
parts valuation. This valuation implies an EV/EBITDA of 16x and 11.8x for
FY08–09E compared to the Asia Pacific peer average of 12.8x and 9.8x,
respectively.
China has been undergoing a capital expenditure boom in infrastructure over the
past decade. In the 11th Five-Year Plan (2006–10E), the Ministry of
Communications’ budget for transport infrastructure spending is Rmb3.8tr,
representing a significant increase from the Rmb2.2tr in the previous five-year
period. Railway is a major beneficiary of the budget with an allocation of
Rmb1.25tr and CRCC is the dominant contractor in the industry. We believe the
best way to benefit from the spending boom is via construction companies and
railway equipment makers. We estimate CRCC’s order backlog will rise from
Rmb323bn as at December 2007 to Rmb447bn in 2009.
Strong operating leverage
We think CRCC’s cost control initiatives would lead to margin expansion and
reduction of working capital. We expect gross profit margin for the company to
expand from 6.6% in 2007 to 7.7% by 2010. For every 0.1ppt change in
construction gross profit margin, we estimate the impact on net profit to be 3.1%.
Any reference pricing review by the Ministry of Railway (MOR) would also be
positive. Construction makes up about 94% of the company’s revenues and
85% of operating profit. Within the construction business, railway and highway
construction make up the biggest proportions at 45% and 34%, respectively.
CRCC is also China’s fastest-growing overseas construction contractor in terms
of new contract value. Overseas contracts make up 36% of its construction
backlog, or roughly Rmb117bn as at 31 December 2007.
Bullish 2008 outlook
Its recent 2007 results were slightly ahead of prospectus forecast and 2008 has
started positively with continued gross profit margin expansion to 7.14% in 1Q08.
We think there is earnings upside risk for the full year as the railway reference
price adjustment is better than expected for high speed railway projects. Our
FY08 earnings forecast of Rmb4.7bn is about 7% above consensus.
Risks
At the industry level, CRCC is exposed to regulatory risks in regards to
government spending on infrastructure and macro-economic controls on the real
estate market. Rising raw material costs and lack of pricing power for railway
construction projects in China are the major risks at the company level.