Gearing up for golden growth period
Railway construction offers a golden ticket to investors
Increased infrastructure investment is now China’s strongest weapon in
fighting the economic downturn, and we believe that railway investments
are at the top of the list. As two dominant infrastructure construction
companies, China Railway Group (CRG) and China Railway
Construction Corp (CRCC) will benefit from upcoming extensive
infrastructure investments. The recent spate of larger banking loans will
pave the way for the increasing infrastructure investments ahead. The
stronger-than-expected, newly added order value in 1Q09 should serve
as a short-term catalyst.
Margin still on the expansion track
Margin improvement should be another engine for CRG and CRCC’s
strong earnings growth. We expect the gross margin to expand slightly
and we are more optimistic on SG&A cost reductions. There is still
abundant room for management improvement in the future: the reduction
of management layers, central procurement of raw materials and
equipment, and centralized capital utilisation will help CRG and CRCC
improve efficiency and lift their margins.
We prefer CRCC to CRG
We prefer CRCC over CRG given the better cost management, stronger
order backlog and new order growth, and for its greater focus on its main
primary business. At the same time, however, CRG has more room for
improvement than CRCC, if CRG makes a greater effort in this respect.
Re-entry opportunity emerges after recent dips: BUY
We believe the recent share-price dips provide re-entry opportunity for
investors to get in on CRG and CRCC’s growth opportunities in the next
couple of years. We forecast CRG and CRCC will achieve 47.4% and
52.6% of earnings CAGR in 2007-10E. We use DCF to derive our target
price for CRG and CRCC at HKD5.70 and HKD12.70 respectively,
assuming 12.0% and 10.8% of WACC for each and 0% of terminal
growth rate for both. Our target price of CRG and CRCC implies 18.4x
and 20.6x 2009E P/E and 13.7x and 16.6x 2010E P/E for CRG and
CRCC respectively. BUY on CRG and CRCC.
Contents
Infrastructure construction: Building an arsenal............................................................. 3
Railways: Compensation for historical underinvestment 3
Can a massive railway expansion be fully financed? 5
Competitive landscape: CRG and CRCC still dominant 7
Overseas construction: short-term pain, long-term gain 8
Highway construction: positive growth to be extended 9
Metro railway construction: Let the good times roll 10
A history of infrastructure-investment overspends 11
BT and BOT business: LT cash flow and higher return 12
Margin improvement expected .................................................................................... 14
CCCC: a successful example 14
More conservative on gross margin improvement 15
Raw materials price drop is positive for margin 16
Big room for SG&A management improvement 17
Margin performance to decide valuation level 17
Growth in railway construction value chain.................................................................. 18
Railway exploration and design: busiest time is now 19
Equipment manufacturing: laggard growth compared to design and construction 19
Our view of businesses diversification 20
CRG vs CRCC: We prefer CRCC................................................................................ 22
CRCC has better company management 22
Stronger order backlog for CRCC over CRG 23
CRCC is more focused on its main business 24
Recent dips provide re-entry opportunities .................................................................. 25
High earnings growth, clear visibility = premium 25
DCF to derive our target price, BUY on CRG and CRCC 25
Valuation of global construction companies 27
Re-entry opportunity emerges after recent dips 28
Appendices .................................................................................................................. 30
1. Devil’s advocate: Risks to our investment case 30
2. Company structure 32
Company updates........................................................................................................ 35
China Railway 36
China Railway Construction 39