Sector Report...freight transportation, railway facilities, and technical services. The Company also sells food, beverages and merchandise on aboard and in train stations. 5,355 …

1

Sector Report

February 21, 2017

Kelly Zou—Analyst

(852) 3698-6319

[email protected]

Wong Chi Man—Head of Research

(852) 3698-6317

[email protected]

Railway investment focus shifting to late-cycle operations; Guangshen Railway and CRSC top picks

Investment focus shifting to late-cycle operations. We expect railway investment to

stay firm in the 13th FYP (2016-2020), led by intercity railway and urban transit network

development. We estimate that railway investment will grow 24.3% in the 13th FYP and

that total investment in urban transit networks will grow 79.8%, reaching >RMB2.2trn. We

expect limited growth for railway construction In the 13th FYP due to the high-base effect,

but we expect much higher growth for late-cycle railway investment related to equipment

procurement, maintenance and upgrades from 2017 onwards. We expect rolling stock

investment to grow 31.6% and railway maintenance spending to more than triple, but

construction investment to grow only 4.9%.

Accelerating railway reform to help resolve funding issues. The central government is

promoting public-private partnership (PPP) projects to sustain infrastructure FAI growth.

Total investment in all PPP projects the NDRC released by the end of 2016 reached

RMB13.5trn, 6.9x the investment value of the first batch of PPP projects announced in

May 2015. Progress, however, is far from satisfactory, considering only 32% of the PPP

projects had properly started by the end of 2016. We believe CRC has to accelerate

railway business reforms to improve railway profitability; otherwise, private investors won’t

participate in these railway projects. Key measures include raising passenger tariffs,

increasing HSR density, expanding freight business and developing land resources.

CRC highly likely to lift railway passenger tariffs in 2017. In Dec 2016, the NDRC

published a document titled “Tentative Measures for the Supervision and Examination of

Transport Cost Pricing for Normal Passenger Trains” for public consultation, signalling

railway passenger tariff reform is likely to happen in 2017. Railway passenger tariff base-

rate hikes have been suspended since 1995, making rail tariffs well below those of airlines

and highways. We expect CRC to raise passenger tariffs for regular train service in 2017

after it finishes the cost examination required by the NDRC. This should help railways

improve margins and resolve funding issues.

Order of preference: Guangshen Railway (GSR), CRSC, CRRC Times Electric,

CRRC. We believe CRC’s focus on operations should drive an increase in operation

spending on equipment. Meanwhile, we expect railway operators to benefit from

passenger tariff hikes. Guangshen Railway and CRSC are our top picks due to their

superior earnings growth outlook compared to their peers and construction companies.

China railway sector

Source: Bloomberg, CGIS Research estimates

Note: pricing based on Feb 20, 2017

Sources: Bloomberg, CGIS Research estimates

Ticker Mkt cap Up/Down PEG

US$ m % 2015 2016E 2017E 2015 2016E 2017E 2017E

Guangshen Railway 525 HK 5,355 4.88 5.81 Buy 19.1% 28.6 22.7 19.8 61.8% 25.8% 14.9% 1.3

CRSC 3969 HK 7,025 6.20 7.74 Buy 24.8% 17.0 16.0 13.5 11.4% 6.4% 17.7% 0.8

CRRC 1766 HK 40,886 7.46 7.72 Hold 3.5% 15.3 14.9 15.4 5.9% 2.2% -3.1% -5.0

CRRC Times Electric 3898 HK 6,657 43.95 47.60 Hold 8.3% 15.5 15.4 13.9 23.5% 0.7% 10.9% 1.3

Ticker

2015 2016E 2017E 2015 2016E 2017E 2015 2016E 2017E 2015 2016E 2017E

Guangshen Railway 525 HK 1.1 1.1 1.1 10.2 8.8 8.1 1.5% 1.8% 2.1% 4.0% 4.9% 5.5%

CRSC 3969 HK 2.6 2.2 2.0 9.6 7.7 6.3 0.4% 1.0% 1.2% 15.1% 14.0% 14.5%

CRRC 1766 HK 1.9 1.7 1.5 7.4 6.7 5.9 1.8% 1.8% 1.8% 12.2% 11.5% 9.9%

CRRC Times Electric 3898 HK 3.4 2.9 2.5 11.9 10.6 9.2 0.9% 0.9% 1.0% 22.0% 18.7% 17.7%

P/Bk EV/EBITDA Dividend yield ROE

Price

(lc) PT (lc) Rec

PER EPS growth

Company Ticker RatingPrice

(HK$)

PT

(HK$)+/-upside

GSR 525 HK Buy 4.88 5.81 19.0%

CRSC 3969 HK Buy 6.20 7.74 24.8%

CRRC 1766 HK Hold 7.46 7.72 3.5%

CRRC Times Electric 3898 HK Hold 43.95 47.6 8.3%

2

Investment thesis: investment focus shifting to

late-cycle operations

The central government will make infrastructure investment a key measure of stability

for GDP growth. As one of the key subsectors, railway investment should stay firm in

the 13th FYP. But we expect only modest investment growth from national railway de-

velopment due to a high base. The growth will come mainly from intercity railway and

urban transit network investment in the 13th FYP (Fig 1).

We estimate that railway investment, including the intercity railway network, will reach

over RMB4.4trn in the 13th FYP, a rise of 24.3% over total investment in the 12th FYP.

Total investment in the national railway network will be largely flat at RMB3.5trn in the

13th FYP, so investment in intercity rail will drive railway investment growth. We fore-

cast that total investment in urban transit networks will grow 79.8% in the 13th FYP,

reaching >RMB2.2trn.

Sources: CRC, China Association of Metros, CGIS Research estimates

Figure 1: Rail transportation investment

We believe the railway investment focus will shift to late-cycle investment. Fast de-

velopment of rail development is forcing CRC and metro line operators to focus more

on business operations and reform, which serves the purpose of improving rail profit-

ability to resolve railway funding issues.

We expect rolling stock investment to grow 31.6% in the 13th FYP and railway

maintenance spending to more than triple. We expect construction investment to

grow only 4.9% in the 13th FYP.

New line addition (km) 2011 2012 2013 2014 2015 2016 2017E 2018E 2019E 2020E 12th FYP 13th FYP

13th FYP vs.

12th FYP

Regular railway 531 1,507 2,472 5,360 5,942 1,390 4,516 4,516 2,316 2,316 15,811 15,053 -4.8%

High-speed railway 1,540 2,762 3,101 3,067 3,589 1,104 2,534 1,903 3,490 4,385 14,059 13,416 -4.6%

Intercity railway 0 0 0 0 0 787 321 877 1,824 2,246 0 6,055 na

Railway subtotal 2,071 4,268 5,573 8,427 9,531 3,281 7,371 7,296 7,630 8,946 29,870 34,524 15.6%

Urban transit network 200 400 538 196 827 503 734 734 979 979 2,161 3,928 81.8%

Investment (Rmb bn)

Regular railway 271 344 356 472 417 416 256 291 342 404 1,861 1,709 -8.2%

High-speed railway 323 313 308 337 406 386 423 340 343 300 1,688 1,791 6.1%

Inter-city railway 0 0 0 0 0 189 188 200 188 147 0 911 na

Railway subtotal 595 658 664 809 824 991 867 830 872 850 3,549 4,411 24.3%


Railway construction 460 522 550 655 592 735 611 544 545 480 2,779 2,915 4.9%

Rolling stock 104 104 87 129 146 147 130 141 157 174 570 750 31.6%

Railway maintenance 31 32 27 25 85 109 126 145 170 196 200 746 273.0%

Total 595 658 664 809 824 991 867 830 872 850 3,549 4,411 24.3%

3

For railway operators, we expect accelerating railway passenger and freight business

reform to help them enhance profitability. Also, mixed-ownership reform in areas of

land resource development and likely future asset injections should drive share price

performance.

1st year 3rd year 4th year2nd year

Design,preparation

Rail bed construction

Bridge tunnel construction

Track construction

Electrification

Control system

Rolling stock

Test run

Operation

Construction companies

Control system producers

Rolling stock companies, railway equipment companies

Operators

Service ramp-up, maintenanceOperation safety and efficiencyRailway business reform

Sources: CGIS Research estimates

Figure 2: Railway sector value chain shift and key industry players’ growth prospects

Mkt cap

Company Ticker Business (US$ m) 2015 2016E 2017E 2015 2016E 2017E 2015 2016E 2017E

CRCC 1186 HK

China Railway Construction Corporation Limited is a full service

construction company. The Company's services include construction

operations, survey design and consulting. China Railway also has

manufacturing operations, real estate operations, and logistics.

24,908 10.1 9.6 8.7 3.2% 5.5% 10.5% 11.9% 11.3% 11.3%

CRG 390 HKChina Railway Group Ltd. offers transportation systems construction

services. The Company builds railroads, roads, tunnels, and bridges.28,537 11.7 10.7 9.7 10.0% 9.6% 10.5% 10.2% 9.7% 9.9%

CCC 1800 HK

China Communications Construction Company Limited is a

transportation infrastructure group. The Company is involved in

infrastructure construction, infrastructure design, dredging, and port

machinery manufacturing. China Communications has operations

worldwide.

36,793 9.3 8.5 7.7 13.8% 8.9% 11.1% 12.0% 11.4% 11.5%

CRSC 3969 HK

China Railway Signal & Communication Corporation Limited

manufactures rail transit related systems. The Company researches,

develops, designs, manufactures, sells and installs rail transit

communication and signal systems. China Railway Signal &

Communication also provides consulting, design and supervision

work for urban transit projects and mainline railway projects.

7,025 17.0 16.0 13.5 11.4% 6.4% 17.7% 15.1% 14.0% 14.5%

CRCC 1766 HK

CRRC Corp Ltd provides a wide range of rolling stock products and

services. The Company's products include locomotives, passenger

carriages, freight wagons, MUs, rapid transit vehicles and key

related components.

40,885 15.3 14.9 15.4 5.9% 2.2% -3.1% 12.2% 11.5% 9.9%

CRRC Times Electric 3898 HK

Zhuzhou CRRC Times Electric Co Ltd provides and integrates train-

borne electrical systems for the PRC Railway industry. The

Company also develops, manufactures, and sells train power

converters, auxiliary power supply equipment and control systems

for trains for urban rail systems.

6,657 15.5 15.4 13.9 23.5% 0.7% 10.9% 22.0% 18.7% 17.7%

Guangshen Railway 525 HK

Guangshen Railway Company Limited provides railroad passenger,

freight transportation, railway facilities, and technical services. The

Company also sells food, beverages and merchandise on aboard and

in train stations.

5,355 28.6 22.7 19.8 61.8% 25.8% 14.9% 4.0% 4.9% 5.5%

PE EPS growth ROE

Early-cycle

construction

Late-cycle

equipment

and operator

4

Stock picks: Guangshen Railway and CRSC

We have initiated coverage on four stocks in the railway sector, focusing on railway

equipment producers and railway operators because we expect limited growth in rail-

way construction investment in the 13th FYP due to the high-base effect. But we expect

much higher growth for late-cycle railway investment related to railway equipment pro-

curement, maintenance and upgrades from 2017 onwards.

We believe huge financial pressure will force CRC to deepen its business reform in the

areas of tariff reform, an HSR service density increase, freight business expansion and

land resource development. We believe CRC’s shift in focus to railway operations

should drive maintenance and operation spending on equipment. The expected pas-

senger tariff hike should boost railway operators’ earnings. Guangshen Railway and

CRSC are our top picks. As Fig 3 suggests, these two companies have higher earn-

ings growth potential than early-cycle construction companies and their late-cycle

peers. In addition, our 2017E EPS growth for Guangshen Railway does not include any

potential upside from tariff hike.

Figure 3: Valuation sheet

Sources: Bloomberg, CGIS Research estimates, Note: share price updated as at Feb 20, 2017

Guangshen Railway: (525 HK): top pick with a Buy rating and target price (TP)

of HK$5.81

We initiate coverage on Guangshen Railway with a Buy rating and TP of HK$5.81,

implying 19.1% upside potential. We believe further share price upside will come from

a railway passenger tariff hike and likely other railway reform gesture in 2017. We

forecast that the Company’s net profit will grow at a CAGR of 13.3% in 2016-2018,

driven by 1) growth recovery in its passenger and freight business, and 2) business

expansion related to its services. We didn’t include the earnings impact from a possi-

ble passenger tariff hike. Our earnings sensitivity analysis shows that every 5ppt in-

crease in its regular train passenger yield growth will boost our earnings forecast for

the Company by >10% in 2017.

Our TP is based on a target multiple of 23.5x 2017E PER. Historically, the company

traded at average forward PER of 17.9x. Currently, the stock is trading at 19.8x

2017E PER. We think a higher target multiple is justified for the Company, consider-

ing we didn’t include any earnings impact from potential passenger tariff hikes. In the

longer term, share price catalysts will also come from CRC’s deepening reform in the

areas of land resource development and likely asset injections. We don’t rule out

Ticker Mkt cap Up/Down PEG

US$ m % 2015 2016E 2017E 2015 2016E 2017E 2017E

Guangshen Railway 525 HK 5,355 4.88 5.81 Buy 19.1% 28.6 22.7 19.8 61.8% 25.8% 14.9% 1.3

CRSC 3969 HK 7,025 6.20 7.74 Buy 24.8% 17.0 16.0 13.5 11.4% 6.4% 17.7% 0.8

CRRC 1766 HK 40,886 7.46 7.72 Hold 3.5% 15.3 14.9 15.4 5.9% 2.2% -3.1% -5.0

CRRC Times Electric 3898 HK 6,657 43.95 47.60 Hold 8.3% 15.5 15.4 13.9 23.5% 0.7% 10.9% 1.3

CRG 390 HK 28,534 7.00 NR NR NR 11.7 10.7 9.7 10.0% 9.6% 10.5% 0.9

CRCC 1186 HK 24,906 11.20 NR NR NR 10.1 9.6 8.7 3.2% 5.5% 10.5% 0.8

CCC 1800 HK 36,789 10.24 NR NR NR 10.7 9.6 8.6 11.6% 11.0% 11.1% 0.8

Ticker

2015 2016E 2017E 2015 2016E 2017E 2015 2016E 2017E 2015 2016E 2017E

Guangshen Railway 525 HK 1.1 1.1 1.1 10.2 8.8 8.1 1.5% 1.8% 2.1% 4.0% 4.9% 5.5%

CRSC 3969 HK 2.6 2.2 2.0 9.6 7.7 6.3 0.4% 1.0% 1.2% 15.1% 14.0% 14.5%

CRRC 1766 HK 1.9 1.7 1.5 7.4 6.7 5.9 1.8% 1.8% 1.8% 12.2% 11.5% 9.9%

CRRC Times Electric 3898 HK 3.4 2.9 2.5 11.9 10.6 9.2 0.9% 0.9% 1.0% 22.0% 18.7% 17.7%

CRG 390 HK 1.2 1.0 1.0 8.9 7.9 7.1 1.1% 1.2% 1.3% 10.2% 9.7% 9.9%

CRCC 1186 HK 1.2 1.1 1.0 6.5 5.1 4.8 1.2% 1.3% 1.5% 11.9% 11.3% 11.3%

CCC 1800 HK 1.1 1.1 1.0 9.5 9.1 8.6 1.9% 2.1% 2.4% 10.6% 11.1% 11.2%

Price

(lc) PT (lc) Rec

PER EPS growth

P/Bk EV/EBITDA Dividend yield ROE

5

the possibility that any other accelerating reform indicators from CRC will also drive

GSR’s share price higher.

CRSC (3969 HK): Top pick in railway equipment sector with a Buy rating and TP

of HK$7.74

We initiate coverage of CRSC with a Buy rating and TP of HK$7.74. CRSC is our top

pick in the railway equipment sector because of its high earnings visibility. The Compa-

ny is involved in both early- and late-cycle railway investment. Even if new line addition

slows down, CRSC can benefit from an increase in demand for its products and ser-

vices related to railway maintenance and operations. We expect its earnings to grow at

a CAGR of 18.3% in 2016-2018. CRSC has Rmb14bn cash on hand at the end of

1H16, which was 29% of its market cap. The Company is likely to have some overseas

M&As to enrich its technology and product offering for long-term growth. We think mar-

ket underappreciates its uniqueness in the industry value chain and the fact that it is a

system integrator, not just an equipment producer.

Our TP is based on a target multiple of 17.0x 2017E PER. Historically, the stock has

traded at 13.3x PER. Currently, the stock is trading at 13.5x 2017E PER. We think the

market underappreciates its uniqueness in the rail investment value chain and also the

fact that it is a systems integrator, not just an equipment producer.

CRRC (1766 HK): Initiate coverage with Hold rating and TP of HK$7.72

We initiate coverage on CRRC with a Hold rating and TP of HK$7.72. We believe its

share price rerating will be constrained by slow earnings growth recovery in 2017. With

declining locomotive and MU sales, we expect its earnings growth to be dampened in

2016-2017. Considering maintenance revenue accounts for ~10% of its total revenue,

we think the growth recovery from increasing railway operations and maintenance

spending will result in slower earnings growth than for CRSC and CRRC Times Elec-

tric. We expect its earnings to remain flattish in 2016-2017 and expect earnings growth

to recover only in 2018.

We set our TP at HK$7.72 and have a Hold rating for CRRC. Our TP is based on a

target multiple of 16.0x 2017E PER and suggests 3.5% upside potential. Historically,

the stock has traded at an average 18.6x PER. Currently, it trades at 15.4x 2017E

PER.

CRRC Times Electric (3898 HK): Initiate coverage with a Hold rating and TP of

HK$47.60

We initiate coverage on CRRC Times Electric with a Hold rating and a TP of

HK$47.60. We expect its earnings growth to recover in 2017. We forecast that net

profit will grow at a CAGR of 12.1% in 2016-2018. We expect likely falling MU product

business revenue to constrain its earnings growth in 2017. But we believe its urban

transit product sales and other new business sales growth will remain firm, which par-

tially offsetting the growth slowdown in its railway business. We expect cost savings

from its acquisition of the IGBT production line to only help it maintain stable margins.

We think its earnings growth recovery in 2017 has largely factored into the share price.

Further share price catalyst would be CRC’s incoming MU tenders to bring more clarity

to its earnings growth outlook in 2017 and 2018.

Our TP is based on a target multiple of 15.0x 2017E PER, which suggests 8.3% up-

side potential. The stock has historically traded at an average PER of 18.7x.

6

Figure 6: A-share-related railway operators and railway equipment companies

Sources: Bloomberg, CGIS Research estimates, Note: share price updated as at Feb 17, 2017


Figure 4: Railway operators’ 2017E PER vs. EPS growth Figure 5: Railway equipment producers’ 2017E PER vs. EPS growth


with a slower EPS growth, we believe a lower PER multiple is appropriate. Further

share price catalyst would be CRC’s incoming MU tenders to bring more clarity to its

earnings growth outlook in 2017 and 2018.

Guangshen Railway offers superior earnings growth opportunities compared to its

peers in domestic and overseas markets before factoring in the positive earnings im-

pact of potential passenger tariff hikes in 2017.

With its high earnings growth visibility, CRSC should trade at a higher valuation than its

domestic peers, given its unique position in the railway investment value chain. We

expect its earnings to grow at a CAGR of >18% in 2016-2018, vs. its peers’ earnings,

which we expect to grow at a CAGR of 13-14% in the same period.

Among A-share related companies in the railway sector, we highlight China Railway

Tielong for railway operators and Beijing Dinghan and China High-Speed Railway for

railway equipment producers.

Guangshen Railway

Daqin Railway

China Railway Tielong

East Japan Railway

Central Japan Railway

West Japan Railway

Norfolk Southern

CSX Corp

Union Pacific Corp

Canadian National Railway

Canadian Pacific Railway

0.0

5.0

10.0

15.0

20.0

25.0

30.0

35.0

40.0

45.0

50.0

0.0% 2.0% 4.0% 6.0% 8.0% 10.0% 12.0% 14.0% 16.0%

2017E PE

EPS growth

CRSCCRRC

CRRC Times Electric

Beijing Dinghan

Zhejiang Yonggui

Siemens

AlstomGE

ABB

Schindler

Ansaldo STS

Hollysys

0.0

5.0

10.0

15.0

20.0

25.0

30.0

35.0

-10.0% 0.0% 10.0% 20.0% 30.0% 40.0% 50.0% 60.0% 70.0% 80.0%

EPS growth

2017E PE

Mkt cap

Company Ticker Business Railway business reform Rail investment Railway operation spending US$ m 2015 2016E 2017E 2015 2016E 2017E 2015 2016E 2017E

Daqin Railway 601006 CH Daqin Railway mainly provides coal transportation service in Northern China. It

also operates passenger transportation business.

Freight business development 15,262 7.4 12.4 11.0 -10.5% -40.7% 12.5% 14.4% 8.2% 8.8%

China Railway Tielong 600125 CH China Railway Tielong Container Logistics provides railroad, truck, and water

transportation and related warehousing services. It also manufactures concrete,

develops real estate, and operates in commercial trading.

Freight business development 1,950 42.3 43.3 40.3 -17.9% -2.3% 7.6% 5.9% 5.8% 7.9%

Beijing Dinghan 300011 CH Beijing Dinghan Technology develops, manufactures and sells electrical

equipments for rail transit electricity systems. The Company also provides

related technical support services.

New line addition Rising maintenance and operation demand on

equipments and components

1,487 34.2 43.4 25.6 29.7% -21.4% 69.5% 15.6% 8.2% 12.3%

China High-Speed Railway Technology000008 CH China High-Speed Railway Technology mainly focuses on the safe operation and

maintenance of rail transport lines.



3,578 99.5 43.1 31.8 1031.0% 130.8% 35.6% 10.7% 11.2% 13.9%

Baotou Beifang Chuangye 600967 CH Baotou Beifang Chuangye designs, manufactures and markets railway cars,

special purpose vehicles, metallurgical equipments, pressure containers and

vehicle parts.



3,513 -183.6 45.3 35.7 -128.3% -505.8% 26.8% -2.5% na na

Henan Thinker Automation Equipment603508 CH Henan Thinker Automation Equipment manufactures automation monitoring

equipment. The Company develops, designs, produces, and sells train

monitoring and recording devices and ancillary equipment. Henan Thinker

Automation Equipment provides its products for electric locomotives and high-

speed passenger trains.



1,426 24.1 35.3 26.4 13.1% -31.6% 33.8% 17.7% na na

Zhejiang Yonggui 300351 CH Zhejiang Yonggui Electric Equipment Company develops, manufactures and

sells rail transit connectors. The Company's main products include railway-bus

connectors, railway-locomotive connectors, urban rail vehicle connectors, and

enhanced mini-USB connectors.



1,304 60.7 38.5 27.0 1.2% 57.5% 42.9% 11.1% 16.1% 18.8%

Nanjing Kangni Mechanical 603111 CH Nanjing Kangni Mechanical&Electrical Company develops, manufactures and

sells door system of rail transport, provides rail transportation equipment and

ancillary products and technical services.



na na na na 8.1% 30.0% 31.3% 17.8% 16.2% 18.6%

Share price catalyst EPS growth ROEPE

7

Figure 7: Railway sector valuation comparison

Sources: Bloomberg, CGIS Research estimates, Note: based on closing prices of 20 February 2017

Ticker Mkt cap PEG

US$ m 2015 2016E 2017E 2015 2016E 2017E 2017E 2015 2016E 2017E 2015 2016E 2017E 2015 2016E 2017E 2015 2016E 2017E

H-share railway operators

Guangshen Railway 525 HK 5,355 4.88 5.81 Buy 28.6 22.7 19.8 61.8% 25.8% 14.9% 1.3 1.1 1.1 1.1 10.2 8.8 8.1 1.5% 1.8% 2.1% 4.0% 4.9% 5.5%

MTR Corp 66 HK 31,120 40.90 NR NR 21.9 26.1 25.3 -30.7% -15.9% 2.9% 8.8 1.4 1.5 1.6 15.3 16.5 16.0 2.6% 8.0% 8.0% 6.4% 5.7% 6.3%

Daqin Railway 601006 CH 15,260 7.06 NR NR 8.3 14.0 12.5 -10.5% -40.7% 12.5% 1.0 1.2 1.1 1.1 5.4 8.1 7.4 6.4% 3.8% 3.9% 14.2% 8.2% 8.8%

Guangshen Railway 601333 CH 5,354 5.42 NR NR 36.1 28.8 24.7 66.7% 25.3% 16.5% 1.5 1.4 1.4 1.3 12.7 10.8 9.7 1.5% 1.7% 2.0% 3.9% 4.7% 5.3%

China Railway Tielong 600125 CH 1,949 10.27 NR NR 47.8 48.9 45.4 -17.9% -2.3% 7.6% 6.0 2.8 2.7 2.5 26.5 23.1 23.2 0.7% 0.6% 0.7% 5.8% 5.4% 5.6%

Sector weighted average 18.0 20.3 18.0 1.5 1.4 1.3 1.3 8.8 9.9 9.2

East Japan Railway 9020 JP 35,352 10,275 NR NR 16.4 14.8 14.0 36.4% 11.0% 5.8% 2.4 1.6 1.5 1.4 8.3 8.4 8.1 1.3% 1.3% 1.4% 10.0% 10.3% 10.0%

Central Japan Railway 9022 JP 33,890 18,620 NR NR 10.9 10.0 9.7 27.8% 8.9% 2.9% 3.3 1.6 1.4 1.2 6.7 6.2 6.1 0.7% 0.7% 0.7% 14.6% 13.8% 12.6%

West Japan Railway 9021 JP 12,581 7,350 NR NR 16.6 14.0 12.9 28.7% 18.1% 8.5% 1.5 1.6 1.5 1.4 7.1 7.3 6.9 1.8% 1.9% 2.1% 9.8% 10.6% 10.6%

Tokyu Corp 9005 JP 9,121 826.00 NR NR 18.4 15.5 17.3 36.3% 18.9% -10.5% -1.7 1.8 1.6 1.5 13.0 12.2 11.9 1.0% 1.1% 1.1% 9.5% 10.4% 8.6%

Tobu Railway 9001 JP 5,445 573.00 NR NR 22.4 17.4 16.4 -11.0% 28.8% 5.9% 2.8 1.6 1.5 1.4 12.1 11.5 11.2 1.0% 1.0% 1.0% 7.0% 8.4% 8.3%

Norfolk Southern NSC US 35,674 122.78 NR NR 23.2 22.0 20.0 -17.2% 5.5% 10.1% 2.0 3.0 3.0 2.9 11.3 10.9 10.3 1.9% 1.9% 2.0% 12.9% 13.5% 14.3%

CSX Corp CSX US 44,970 48.54 NR NR 24.3 26.8 24.2 4.2% -9.4% 10.8% 2.2 4.0 3.8 3.7 11.5 12.2 11.6 1.4% 1.5% 1.6% 16.6% 14.3% 15.3%

Union Pacific Corp UNP US 89,371 109.82 NR NR 20.0 21.9 19.5 -4.5% -8.8% 12.7% 1.5 4.5 4.5 4.5 10.2 11.2 10.5 2.0% 2.1% 2.2% 22.5% 20.6% 23.2%

Kansas City Southern KSU US 9,266 86.89 NR NR 19.4 19.4 17.1 -6.8% -0.2% 13.3% 1.3 2.4 2.2 2.1 10.6 10.4 9.6 1.5% 1.5% 1.6% 12.5% 11.6% 12.2%

Genesee & Wyoming GWR US 4,681 75.39 NR NR 18.2 21.3 23.2 -9.2% -14.6% -8.4% -2.8 1.7 1.5 1.4 12.1 12.8 9.7 0.0% 0.0% 0.0% 9.5% 7.0% 6.1%

Canadian National Railway CNR CN 54,485 93.85 NR NR 21.1 20.5 18.9 18.1% 3.1% 8.2% 2.3 4.9 4.8 4.6 12.7 12.6 12.1 1.3% 1.6% 1.8% 23.4% 23.2% 24.1%

Canadian Pacific Railway CP CN 21,893 195.89 NR NR 19.4 18.9 17.1 18.8% 2.8% 10.3% 1.7 6.2 5.9 5.1 11.3 11.5 10.8 0.7% 0.9% 1.1% 32.2% 31.2% 29.7%

Sector weighted average 19.6 19.7 18.1 1.9 3.6 3.5 3.3 10.4 10.7 10.1

CRSC 3969 HK 7,025 6.20 7.74 Buy 17.0 16.0 13.5 11.4% 6.4% 17.7% 0.8 2.6 2.2 2.0 9.6 7.7 6.3 0.4% 1.0% 1.2% 15.1% 14.0% 14.5%

CRRC 1766 HK 40,886 7.46 7.72 Hold 15.3 14.9 15.4 5.9% 2.2% -3.1% -5.0 1.9 1.7 1.5 7.4 6.7 5.9 1.8% 1.8% 1.8% 12.2% 11.5% 9.9%

CRRC Times Electric 3898 HK 6,657 43.95 47.60 Hold 15.5 15.4 13.9 23.5% 0.7% 10.9% 1.3 3.4 2.9 2.5 11.9 10.6 9.2 0.9% 0.9% 1.0% 22.0% 18.7% 17.7%

CRRC 601766 CH 40,881 10.37 NR NR 24.0 24.3 22.6 10.8% -1.2% 7.5% 3.0 2.9 2.6 2.4 11.9 11.5 10.5 1.4% 1.2% 1.4% 12.2% 10.9% 10.8%

China High-speed 000008 CH 3,578 8.76 NR NR 112.3 48.7 35.9 1031.0% 130.8% 35.6% 1.0 7.3 5.2 4.5 88.8 na na 0.0% na na 6.5% 10.7% 12.5%

Guangdong KAIP 000976 CH 2,248 9.69 NR NR 323.0 77.5 35.5 -108.3% 316.7% 118.4% 0.3 23.8 4.5 4.1 167.5 na na 0.0% 0.4% 0.6% 7.4% 5.8% 11.6%

Beijing Dinghan 300011 CH 1,487 19.31 NR NR 38.5 49.0 28.9 29.8% -21.4% 69.5% 0.4 4.9 4.6 4.1 36.1 na na 0.3% 0.4% 0.7% 12.7% 9.3% 14.0%

Nanjing Kangni 603111 CH na na NR NR na na na 8.0% 29.9% 31.3% na na na na na na na na na na 16.5% 16.2% 18.2%

Zhejiang Yonggui 300351 CH 1,303 23.31 NR NR 68.6 43.5 30.4 1.1% 57.6% 42.9% 0.7 7.3 6.1 5.1 55.7 na na 0.3% 0.4% 0.5% 10.7% 14.1% 16.8%

45.4 29.7 24.5 2.6 4.3 3.1 2.8 26.3 9.5 8.6

Siemens SIE GR 109,598 121.40 NR NR 19.0 17.0 15.2 -1.8% 11.9% 12.1% 1.3 2.8 2.8 2.6 13.9 11.6 10.2 2.9% 3.0% 3.2% 15.0% 16.5% 17.0%

Bombardier BBD/A CN 4,359 2.61 NR NR 14.2 -19.5 -64.3 -60.0% -172.9% -69.6% 0.9 -1.0 -0.8 -0.8 -2.4 12.4 11.2 0.0% na na -7.0% 4.3% 1.3%

Alstom ALO FP 6,110 26.20 NR NR -5.4 20.3 16.3 4044.1% -126.3% 25.2% 0.6 1.8 1.7 1.5 14.4 10.0 9.1 0.0% 1.0% 1.6% -32.7% 8.1% 9.5%

GE GE US 268,665 30.37 NR NR 23.2 20.3 18.5 -20.6% 14.0% 9.9% 1.9 2.9 3.3 3.4 32.9 17.9 16.8 3.0% 3.0% 3.1% 12.5% 16.4% 18.6%

ABB ABBN VX 50,537 22.88 NR NR 19.7 20.1 18.7 -4.1% -2.2% 7.7% 2.4 3.5 3.6 3.5 12.2 11.6 10.1 3.4% 3.3% 3.4% 17.6% 17.8% 18.5%

Schindler SCHP VX 20,706 194.10 NR NR 30.9 27.0 24.8 -2.7% 14.6% 8.7% 2.8 9.1 7.8 6.5 17.2 15.1 13.8 1.4% 1.5% 1.7% 29.5% 28.9% 26.3%

Ansaldo STS STS IM 2,485 11.70 NR NR 24.9 28.3 24.4 4.0% -12.1% 16.2% 1.5 3.6 3.3 na 12.9 13.9 12.3 1.5% 1.0% 1.4% 14.4% 11.7% ######

Hollysys HOLI US 1,042 17.42 NR NR 8.6 11.2 8.8 17.4% -23.1% 27.7% 0.3 1.5 1.4 1.2 6.6 7.6 5.7 0.0% 0.9% 1.1% 17.9% 12.1% 13.6%

21.7 19.5 17.2 1.8 3.2 3.4 3.3 24.6 15.4 14.1

CRG 390 HK 28,534 7.00 NR NR 11.7 10.7 9.7 10.0% 9.6% 10.5% 0.9 1.2 1.0 1.0 8.9 7.9 7.1 1.1% 1.2% 1.3% 10.2% 9.7% 9.9%

CRCC 1186 HK 24,906 11.20 NR NR 10.1 9.6 8.7 3.2% 5.5% 10.5% 0.8 1.2 1.1 1.0 6.5 5.1 4.8 1.2% 1.3% 1.5% 11.9% 11.3% 11.3%

CSCI 3311 HK 7,598 13.14 NR NR 12.7 12.2 10.2 16.3% 4.1% 19.7% 0.5 2.5 2.0 1.8 12.6 11.0 9.3 2.4% 2.6% 3.0% 19.8% 16.7% 17.7%

11.2 10.5 9.5 9.5 9.5 9.5 9.5 9.5 9.5 9.5

CRG 601390 CH 28,534 9.13 NR NR 17.2 15.3 13.7 10.0% 12.5% 11.6% 1.2 1.8 1.5 1.4 11.5 10.4 9.6 0.9% 1.0% 1.1% 10.2% 10.1% 10.2%

CRCC 601186 CH 24,906 13.10 NR NR 13.4 12.6 11.3 6.5% 6.4% 10.8% 1.0 1.6 1.4 1.3 7.9 6.7 6.3 1.1% 1.3% 1.4% 11.9% 11.4% 11.4%

15.4 14.0 12.6 1.1 1.7 1.5 1.3 9.8 8.7 8.1

H-share railway equipment companies

A-share railway equipment companies

Overseas railway equipment companies

A-share railway construction companies

EV/EBITDA Dividend yield

H-share construction companies

ROE

A-share railway operators

Overseas railway companies

Price

(lc)

PT

(lc) Rec

PER EPS growth P/Bk

8

Sources: WIND Info, CGIS Research estimates

Infrastructure to remain a key measure for stability

in GDP growth in 2017 We believe the central government will make infrastructure investment a key measure

to maintain stable GDP growth in 2017. China’s real GDP grew 6.7% in 2016, down

from 6.9% in 2015. The central government aims to keep GDP growth from further

sliding. We expect growth to continue to be driven by infrastructure FAI in the areas of

transportation, utilities and environmental protection infrastructure development.

Total FAI grew 8.1% YoY in 2016. Infrastructure FAI grew the most − up 15.8% YoY in

2016 − but the growth was slower than the 17.0% YoY growth in 2015. We expect in-

frastructure FAI to grow by over 15% YoY in 2017. We expect deeper mixed-ownership

reform in railways, oil & gas, and the grid network to help resolve funding issues and

sustain robust infrastructure FAI growth. We expect real estate FAI to become sub-

dued in 2017, as the central government sticks to its tightening policy in the property

market in 2017. We also expect manufacturing FAI growth to be constrained, since 1)

various industries will continue to carry out supply-side reforms to cut industry capacity,

and 2) the private manufacturing sector lacks incentives to invest in new capacity amid

a weak demand outlook.

Figure 8: China’s real GDP growth Figure 9: China’s FAI growth by segment


12.7%

14.2%

9.7%9.4%

10.6%

9.5%

7.9% 7.8%7.3%

6.9% 6.7%

6.0%

7.0%

8.0%

9.0%

10.0%

11.0%

12.0%

13.0%

14.0%

15.0%

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 20160.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

40.0%

45.0%

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Total FAI

Infrastructure FAI

Manufacturing FAI

Real estate FAI

9

Rail transportation investment to remain firm in

the 13th FYP The NDRC released a new medium- to long-term plan for railway development in the

13th FYP. Key tasks include 1) expansion of the HSR network from “Four Vertical and

Four Horizontal” rail lines to “Eight Vertical and Eight Horizontal” rail corridors; 2) the

development of railway coverage in midwestern China; and 3) railway network optimi-

zation in Eastern China.

The NDRC target for total mileage of the national railways is 150,000km, implying new

line addition of >28,000km in the 13th FYP, roughly the same level as in the 12th FYP.

Our calculation shows that new line addition of national HSR lines should reach

>13,000km in the 13th FYP compared with 14,059km in the 12th FYP. We estimate that

new line addition of regular railways will reach >15,000km in the 13th FYP, about the

same level as in the 12th FYP.

Railway investment growth will be driven by the initiatives of local governments to de-

velop the intercity railway network by city clusters. We estimate new line addition of

intercity railways will reach >6,000km in the 13th FYP. Including new line addition of

intercity railways, new line addition of both national railways and intercity railways will

grow 15.6% in the 13th FYP compared with new line addition in the 12th FYP.

Other than intercity railways, local governments will promote the development of urban

transit networks, which serve the purpose of 1) reducing air pollution and traffic con-

gestion, and 2) boosting property values with new lines connecting previously remote

areas with city centres. Industry association data suggests total mileage of urban trans-

it networks will reach 7,500km by 2020, suggesting new line addition of more than

700km per annum in the 13th FYP compared with average new line addition of 400km

in the 12th FYP. Overall, we expect new line addition of urban transit networks to grow

81.8% in the 13th FYP compared with new line addition in the 12th FYP.

Based on our cost assumptions for railway and urban transit network development, we

estimate railway investment, including the intercity railway network, will reach over

RMB4.4trn in the 13th FYP, rising 24.3% compared with total investment in the 12th

FYP. Total investment in the national railway network will be largely flat at RMB3.5trn

in the 13th FYP, as investment for intercity railway will be driven railway investment

growth. We forecast that total investment in urban transit networks will grow 79.8% in

the 13th FYP, reaching >RMB2.2trn.

Sources: CRC, China Association of Metros, CGIS Research estmates

Figure 10: Rail transportation investment

New line addition (km) 2011 2012 2013 2014 2015 13th FYP

13th FYP vs.

12th FYP

Regular railway 531 1,507 2,472 5,360 5,942 15,053 -4.8%

High-speed railway 1,540 2,762 3,101 3,067 3,589 13,416 -4.6%

Intercity railway 0 0 0 0 0 6,055 na

Railway subtotal 2,071 4,268 5,573 8,427 9,531 34,524 15.6%

Urban transit network 200 400 538 196 827 3,928 81.8%

Investment (Rmb bn)

Regular railway 271 344 356 472 417 1,709 -8.2%

High-speed railway 323 313 308 337 406 1,791 6.1%

Inter-city railway 0 0 0 0 0 911 na

Railway subtotal 595 658 664 809 824 4,411 24.3%

Urban transit network 163 191 217 290 368 2,210 79.8%

10

Mixed-ownership reform to resolve funding issues

The railway sector’s monolithic regime, along with the fast development of the costly

HSR network, has placed serious financial pressure on CRC, which relies heavily on

banks and bonds to fund railway development. At end-2015, its total debt stood at

RMB3.4trn, rising 11.2% YoY. Its total debt-to-equity ratio at end-2015 reached

190.4%, rising 0.4ppt YoY. Its profitability remains weak, however, amid weakening

demand for its freight transportation business. Its net profit margin was only 0.2% in

2015. The EBIT/interest expense coverage ratio was only 1.59 in 2015 compared to

1.81 in 2014.

Local governments are also struggling under huge financial pressure from heavy in-

vestment in local infrastructure. The central government’s cooling measures in the

property market have caused a decrease in their core revenue source, land sales,

which make up >50% of their total revenue. Our data shows that bank borrowing and

bond issuance contributed 27% of the funding for local governments’ infrastructure

investment. As at end-2016, total debt for local governments was RMB17.2trn, up

7.2% YoY. To prevent local government debt from further ballooning, the central gov-

ernment set a limit on debt financing by local governments. Instead, the NDRC is pro-

moting the PPP infrastructure development model for local governments.


Figure 11: CRC’s debt financing Figure 12: Local governments’ debt financing (Rmb trn)


0.0%

20.0%

40.0%

60.0%

80.0%

100.0%

120.0%

140.0%

160.0%

180.0%

200.0%

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

2007 2008 2009 2010 2011 2012 2013 2014 2015

Total debt (Rmb bn) Total debt/equity ratio (rhs)

16.00

17.19

15.00

15.50

16.00

16.50

17.00

17.50

2015 2016

11

PPP projects to sustain infrastructure investment

growth, but progress is slow To resolve the funding issue for infrastructure development, the central government is

pushing mixed-ownership reform in the areas of transportation, utilities and environ-

ment protection infrastructure development. Along with the promotion of PPP projects,

the Central Economic Work Conference held in Dec 2016 highlighted that the new

year’s focus would be on mixed-ownership reform in the power, oil & gas, railway, civil

aviation, telecommunications and military sectors. We think railway reform will be a

pilot for other sectors to follow in 2017.

As for PPP projects, the NDRC released 11,260 projects with total investment reaching

RMB13.5trn as at end of 2016, which was 6.9x the investment value for the first batch

of PPP projects the bureau released in May 2015. Progress, however, is far from satis-

factory, considering only 32% of the PPP projects had properly started by end of 2016.

Private investors have hesitated to participate in PPP projects, either because they are

unsatisfied with the investment return or because they are not confident about ade-

quate protection of their interest when cooperating with local governments.


Figure 13: The number and total investment of PPP projects Figure 14: Implementation ratio of PPP projects


15%

17%

19%

21%

23%

25%

27%

Jan

-16

Feb

-16

Mar

-16

Ap

r-16

May

-16

Jun

-16

Jul-

16

Au

g-16

Sep

-16

0.00

2.00

4.00

6.00

8.00

10.00

12.00

14.00

16.00

0

2,000

4,000

6,000

8,000

10,000

12,000

No of projects Total contract value (Rmb trn, rhs)

12

Urgent need to improve railway and urban transit

network profitability

Without improvement in profitability and investment return, it will be slow-going for

mixed-ownership reform to resolve the funding problem for railway development. As a

result, we expect railway investment to accelerate from 2017 onwards. We think rail-

way reform will provide a reform pilot for other sectors to follow.

A rise in railway passenger tariffs is on the agenda. On 1 Dec 2016, the NDRC pub-

lished a document titled “Tentative Measures for the Supervision and Examination of

Transport Cost Pricing for Normal Railway Passenger Trains” for public consultation.

These measures highlighted for the first time a few major cost elements for considera-

tion in setting ticket prices for normal passenger trains: depreciation, labour, mainte-

nance, electricity and fuel. The measures should change the railway passenger tariff

pricing from the current fixed-priced mechanism to a more market-oriented or cost-plus

pricing mechanism.

We think conditions are ripe for railway passenger tariff reform, considering CRC faces

huge financial pressure from the fast development of the railway network. Railway pas-

senger tariff base-rate hikes have been suspended in China since 1995. So far, the

NDRC allows only CRC to set HSR train ticket prices. Railway passenger tariffs in Chi-

na are well below those of other transportation modes, such as airlines and highways

(Fig 15). The railway passenger tariff base-rate in China is also below that of other

overseas railways (Fig 16).


Figure 15: Passenger tariff comparison: railway vs. airlines and highways Figure 16: HSR passenger comparison: China vs. other OECD countries


A rise in railway passenger tariffs is on the agenda

0.11 0.12

0.23

0.40

1.14

0.31

0.00

0.20

0.40

0.60

0.80

1.00

1.20

1.40

Regular trainservice

Regular trainservice (T)

HSR trainservice (D)

HSR trainservice (G)

Airline Highway

Rmb/person-km

0.38

1.731.87

2.11

0.00

0.50

1.00

1.50

2.00

2.50

China France Japan Germany

Rmb/person-km

13

Increasing HSR operation density is another option to enhance railway profitability; this

would enable CRC to charge higher passenger fares. A higher density of HSR train

services would generate more passenger revenue to offset the high fixed costs of HSR

operations.

China launched its first HSR train service in 2007. Since then, passenger traffic has

grown >23x, with market share reaching 51% in 2016, compared with HSR train mar-

ket share of only 5% in 2017.

The operation density of HSR trains in China, however, is still lower than the density of

some overseas HSRs. Even though CRC has increased HSR train service frequency 2

-3 times a year, most of the HSR trains in China run below their designed speed, so

HSR train service in China is still behind that of other developed countries. At end-

2016, China’s HSR train service had 0.11 MUs per km of HSR, while Japan’s Shikan-

sen train service had 0.18 MUs per km of HSR.

We expect the 2016 NDRC announcement of the “Eight Vertical and Eight Horizontal”

HSR network, replacing the Four Vertical and Four Horizontal network, along with pas-

senger traffic growth, will allow CRC to further raise HSR train speed and operation

density. CRC reduced HSR train speed after the tragic train crash in 2011. But after

years of safe operation, we think HSR train service in China is ready for a speed in-

crease. CRC raised the speed of the Hainan East Ring line from 200km/h to its de-

signed speed of 250km/h. We expect higher HSR speeds to come into force from 2017

onwards, which should drive new railway equipment sales and maintenance demand

Increasing HSR train service density is another option

Sources: CRC, CGIS Research estimates

Figure 17: HSR train service ridership and market share in China

0%

10%

20%

30%

40%

50%

60%

0

200

400

600

800

1,000

1,200

1,400

1,600

2007 2008 2009 2010 2011 2012 2013 2014 2015 2016HSR ridership (mn people) HSR market share (%, rhs)

14

Most of the HSR train services in China are loss-making. A World Bank report calcu-

lated that HSR train service revenue in China reached RMB125bn in 2015, which did

not even cover CRC’s annual interest expense of RMB250bn, not to mention CRC’s

depreciation and operation expenses related to HSR train operations.

The urban transit network in China faces the same problem: i.e., passenger transporta-

tion revenue does not fully offset high fixed operation costs. Even for the 13 metro lines

in Beijing, which have more than 10 years’ operation history, depreciation still accounts

for over 50% of its overall operation costs.

As railways and urban transit bring rail connections between remote areas and city

centres, plausible new revenue streams include land resource development in residen-

tial and commercial properties, advertising and retailing.

Hong Kong’s MTR Corporation (MTRC) (66.HK) is the most successful urban transit

network operator in the sense of its business development. It has made good use of

land resource development into residential and commercial properties, which has ena-

bled it to extract revenue from its non-rail transportation businesses, such as the devel-

opment of residential and commercial properties, property leasing and management,

advertising, telecommunication services and international consultancy services to fund

its rail transportation business.

Urban transit networks in China are following the MTRC approach to run their busi-

ness. MTRC is involved in the operation of the No. 4, 13, 16 metro lines and the Dax-

ing Line in Beijing. Shanghai’s Shentong Metro (600834.CH) will make use of its land

resources for property development. Shenzhen Metro Group is more active in property

development than its peers in Beijing and Shanghai. CRC is still in the early stages of

planning of how to utilize its land resources to enhance earnings.

Land resource development to help diversify revenue stream

Sources: Company data, CGIS Research estimates Sources: Company data, CGIS Research estimates

Figure 18: MTR Corp revenue breakdown Figure 19: Net profit margin comparison of metro lines in China. vs. MTR

transport operation, 41%

station commercial

busienss, 13%

property rental and

management business, 11%

mainland China and overseas business, 30%

Other, 6%

11.2%13.2%

10.0%

15.4%14.1%

8.9%

33.7%

38.9%

31.2%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

40.0%

45.0%

2013 2014 2015Shenzhen Metro Group Shanghai Shentong Metro MTR Corp

15

Railways can grow their higher-margin freight business to enhance margins and accel-

erate earnings growth. The market share of railways in the logistics transportation mar-

ket declined from >30% in the 2000s to only 12% in 2016. Historically, the railway net-

work had to prioritize passenger and bulk material transportation. Hence, it has very

limited capacity to capture growth opportunities in China’s non-bulk freight transporta-

tion market, which has been boosted by the booming E-commerce industry.

We expect rail transport to gradually take market share from road and waterway

transport in the domestic logistics transportation industry. Compared to trucks and air-

lines, rail has significant competitive advantages, including suitability for carrying heavy

or bulky goods, high speed, short delivery time, high punctuality and low cost. The for-

mation of the HSR network has gradually developed the capacity for the railway net-

work to expand its freight business. The expansion of the railway freight business will

thus focus on two areas: 1) future development of railway intermodal transportation,

and 2) the launch of high frequency logistics transportation services.

CRC is eyeing the rapidly growing freight express service for the E-commerce industry

in China. Trucks and airfreight dominate the domestic parcel delivery market; rail has

only a 3% market share, while railways in the US have over a 30% market share of the

logistics transportation market. In 2014, CRC launched its express train service and

less-than-truckload freight transportation service for the E-commerce industry. With

more freight transportation capacity and a more open-order receiving system, rail can

attract more logistics companies for less-than-truckload freight transportation. CRC’s

railway logistics companies have built a door-to-door delivery service network, aligning

its freight transportation services more closely to the needs of its customers.

To further grow its bulk and non-bulk material transportation services, CRC aims to

develop its containerized freight transportation service. As China’s economic growth

has shifted to mid-eastern China, freight movement become more frequent between

the coastal and inland cities. For long-distance freight transportation, rail is more suita-

ble. Containerized rail freight transportation allows considerable improvement in the

efficiency of freight movement.

Freight business expansion to help earnings growth

Figure 20: Railway market share of the logistics transportation market

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

Railway Highway Waterway Airline

32.3%

29.4%27.4%

32.1%

27.6%

17.6%

12.3% 11.9%

7.1%

10.0%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

2011 2012 2013 2014 2015

Daqin Railway Guangshen Railway

Figure 21: Operating profit margin; Guangshen Railway vs. Daqin Railway

16

Railway equipment producers and operators to

benefit from railway business reform We expect accelerated railway and urban transit business reform to resolve funding

issues to sustain robust rail and urban transit network investment in the 13th FYP. We

believe the railway investment focus will shift more to late-cycle railway equipment

investment and operations.

Railway equipment producers will benefit from the fast development of railway and

urban transit networks and the railway reforms described in the 13th FYP. We expect

CRC to raise HSR speed and expand its freight business, which should generate de-

mand for MUs and locomotives. In addition, CRC’s has shifted its focus to operations,

which should drive its spending on maintenance and equipment and benefit railway

equipment producers.

Fast development of national railways, intercity railways and urban transit networks

should generate demand growth for rolling stock and signaling systems. A rise in HSR

speed and CRC’s promotion of its freight business will also mean further demand up-

side for railway equipment. With CRC’s focus shifting to operations, maintenance de-

mand will also drive earnings growth for railway equipment producers.

Overall, we expect rolling stock investment to grow 31.6% and railway maintenance

spending to more than triple in the 13th FYP. We believe that CRSC, CRRC Times

Electric and other A-share railway equipment producers have higher earnings growth

potential than CRRC. MU maintenance-related business accounts for ~10% of CRRC’s

total revenue, while the same business should account for at least 50% of the revenue

of CRSC, CRRC Times Electric and other A-share railway equipment companies.

Sources: CRC, CGIS Research estimates

Figure 22: Railway investment breakdown

New line addition (km) 2011 2012 2013 2014 2015 2016 2017E 2018E 2019E 2020E 12th FYP 13th FYP

13th FYP vs.

12th FYP

Regular railway 531 1,507 2,472 5,360 5,942 1,390 4,516 4,516 2,316 2,316 15,811 15,053 -4.8%

High-speed railway 1,540 2,762 3,101 3,067 3,589 1,104 2,534 1,903 3,490 4,385 14,059 13,416 -4.6%

Intercity railway 0 0 0 0 0 787 321 877 1,824 2,246 0 6,055 na

Railway subtotal 2,071 4,268 5,573 8,427 9,531 3,281 7,371 7,296 7,630 8,946 29,870 34,524 15.6%


Investment (Rmb bn)

Regular railway 271 344 356 472 417 416 256 291 342 404 1,861 1,709 -8.2%

High-speed railway 323 313 308 337 406 386 423 340 343 300 1,688 1,791 6.1%

Inter-city railway 0 0 0 0 0 189 188 200 188 147 0 911 na

Railway subtotal 595 658 664 809 824 991 867 830 872 850 3,549 4,411 24.3%


Railway construction 460 522 550 655 592 735 611 544 545 480 2,779 2,915 4.9%

Rolling stock 104 104 87 129 146 147 130 141 157 174 570 750 31.6%

Railway maintenance 31 32 27 25 85 109 126 145 170 196 200 746 273.0%

Total 595 658 664 809 824 991 867 830 872 850 3,549 4,411 24.3%

17

For railway operators such as Guangshen Railway, Daqin Railway (601006.CH) and

China Railway Tielong (600125.CH), we expect accelerating railway passenger and

freight business reform to help enhance profitability. Also mixed-ownership reform in

the areas of land resource development and likely future asset injections should drive

the share price performance of these companies.

Guangshen Railway will be a key beneficiary of potential tariff hikes, given over 45% of

its total revenue is from passenger transportation. Our base-case scenario assumes

that its regular long-distance train passenger yield is to grow 4.0% YoY in 2017, led by

new service introduction. We calculate that another 5ppt increase in our passenger

yield assumption for its regular trains could boost our earnings estimate for the Compa-

ny by >10% in 2017.

Figure 23 Guangshen Railway earnings’ sensitivity to passenger yield change

Source: Company data, CGIS Research estimates

Inter-city train 2017E net profitChange from base

case2016E net profit % YoY chg

Passenger yield change 1,547 1,347

20.0% 1,815 17.3% 34.8%

15.0% 1,726 11.5% 28.1%

10.0% 1,637 5.8% 21.5%

5.0% 1,547 0.0% 14.9%

0.0% 1,458 -5.8% 8.2%

-5.0% 1,369 -11.5% 1.6%

-10.0% 1,279 -17.3% -5.0%

HK-through train 2017E net profitChange from base



20.0% 1,608 3.9% 19.4%

15.0% 1,588 2.6% 17.9%

10.0% 1,568 1.3% 16.4%

5.0% 1,547 0.0% 14.9%

0.0% 1,527 -1.3% 13.4%

-5.0% 1,507 -2.6% 11.9%

-10.0% 1,487 -3.9% 10.4%

Long-distance train 2017E net profitChange from base



19.0% 2,051 32.5% 52.3%

14.0% 1,883 21.7% 39.8%

9.0% 1,715 10.8% 27.3%

4.0% 1,547 0.0% 14.9%

-1.0% 1,380 -10.8% 2.4%

-6.0% 1,212 -21.7% -10.0%

-11.0% 1,044 -32.5% -22.5%

1

Guangshen Railway [525.HK]

BUY

Close: HK$4.88 (Feb 20, 2017)

Target Price: HK$5.81 (+19.0%)

Price Performance

Market Cap US$5,354m

Shares Outstanding 1,431m

Auditor PWC

Free Float 100.0%

52W range HK$3.15-5.17

3M average daily T/O US$23m

Major Shareholding Guangzhou Railway

(Group) Company

(37.1%)

Sources: Company data, Bloomberg

Kelly Zou—Analyst

(852) 3698-6319

[email protected]

Wong Chi Man, CFA—Head of Research

(852) 3698-6317

[email protected]


China Railway Sector

We initiate coverage on Guangshen Railway with a Buy rating and TP of HK$5.81, implying 19.0% upside potential. We believe further share price upside will come from a railway passenger tariff hike and likely other railway reform gestures in 2017. We forecast that the Company’s net profit will grow at a CAGR of 13.3% in 2016-2018, driven by 1) growth recovery in its passenger and freight business, and 2) business expansion related to its services. We didn’t include the earnings impact from a possible passenger tariff hike. Our earnings sensitivity analysis shows that every 5ppt increase in its regular train passenger yield growth will boost our earn-ings forecast for the Company by >10% in 2017. Therefore, we apply a target multi-ple of 23.5x 2017E PER for our TP, above its historical average PER of 17.9x.

Investment Highlights

Traffic diversion from HSR lines no longer a business overhang: We be-

lieve the traffic diversion to its passenger business from HSR lines has largely stabilized. The Company introduced new train services to offset the traffic de-cline from competition with HSRs with its parent company’s support. We expect passenger traffic growth to resume for its three train services from 2017 on-wards, and we forecast that its passenger volume will grow modestly by 1% p.a. in 2017 and 2018. With the introduction of new services, the Company can im-prove its passenger yield, which we expect to grow >4% p.a. in 2017-2018.

Transportation service business expansion a new earnings growth driver:

GSR’s services revenue to HSR lines grew at a CAGR of >30% in 2010-2015. Revenue from those services represented 19% of its total revenue in 2015 vs. only 7% in 2010. We expect its services revenue to grow at a CAGR of 10.9% in 2016-2018, driven by fast passenger traffic growth of HSR lines in Guang-dong province. Based on the comprehensive service framework agreement GSR signed with CRC, the annual cap of its revenue from the services it pro-vides to CRC will grow at a CAGR of >15% in 2016-2018.

Near-term share price catalyst to come from a passenger tariff hike: We

think a rise in the passenger tariff is already on the government’s agenda. Pas-senger tariff rate hikes have been suspended since 1995, so railway tariffs are lower than those of airlines and highways. We didn’t include the earnings impact from a passenger tariff hike in our earnings forecast. Our earnings sensitivity analysis shows that every 5ppt increase in its regular train passenger yield growth will boost our earnings forecast for the Company by >10% in 2017.

Buy with a target price of HK$5.81: Our TP is based on a target multiple of

23.5x 2017E PER. Historically, the Company has traded at an average forward PER of 17.9x. Currently the stock trades at 19.8x 2017E PER. We expect fur-ther share price upside to come from accelerated railway business reform.

INITIATE COVERAGE: Share price upside on potential passenger tariff hike

February 21, 2017

Y/E Dec 31 2013 2014 2015 2016E 2017E 2018E

Turnover (RMB m) 15,801 14,801 15,725 17,371 18,647 19,965

Recurring net profit (RMB m) 1,274 662 1,071 1,347 1,547 1,729

Net margin (%) 8.1 4.5 6.8 7.8 8.3 8.7

Recurring EPS (RMB) 0.18 0.09 0.15 0.19 0.22 0.24

% change -3.4 -48.0% 61.8% 25.8% 14.9% 11.8%

PER(x) 24.0 46.2 28.6 22.7 19.8 17.7

PBR(x) 1.1 1.1 1.1 1.1 1.1 1.1

EV/EBITDA(x) 9.2 12.3 10.2 8.7 8.1 7.6

2

Key financials


Revenue breakdown(Rmb m) 2011 2012 2013 2014 2015 2016E 2017E 2018E

Intercity trains 2,607 2,374 2,416 2,115 2,224 2,359 2,502 2,653

Hong Kong through trains 461 480 498 527 510 528 566 606

Long-distance trains 4,959 4,987 5,144 4,346 4,263 4,432 4,655 4,889

Passenger transportation 8,027 7,841 8,058 6,988 6,998 7,319 7,722 8,148

Freight dispatched 417 462 527 590 565 478 512 559

Freight received 914 832 905 920 1,022 1,127 1,242 1,370

Other 56 50 171 253 174 131 134 138

Freight transportation 1,387 1,344 1,603 1,764 1,761 1,735 1,888 2,067

Railway network usage 3,255 3,474 3,327 2,860 2,934 2,764 2,902 3,062

Railway operation service to new HSRs 1,001 1,416 1,708 2,171 2,941 4,407 4,931 5,424

Other business 1,022 1,016 1,104 1,018 1,092 1,146 1,203 1,264

Total revenue 14,691 15,092 15,801 14,801 15,725 17,371 18,647 19,965

% YoY

Intercity trains 10.4% -8.9% 1.8% -12.4% 5.2% 6.1% 6.1% 6.1%

Hong Kong through trains 11.4% 4.2% 3.8% 5.8% -3.1% 3.5% 7.1% 7.1%

Long-distance trains 7.8% 0.6% 3.1% -15.5% -1.9% 3.9% 5.0% 5.0%

Passenger transportation 8.8% -2.3% 2.8% -13.3% 0.1% 4.6% 5.5% 5.5%

Freight dispatched 22.7% 10.7% 14.2% 12.0% -4.2% -15.5% 7.1% 9.2%

Freight received -1.3% -8.9% 8.8% 1.7% 11.1% 10.3% 10.3% 10.3%

Other 12.6% -10.1% 239.2% 48.0% -31.2% -25.0% 3.0% 3.0%

Freight transportation 5.4% -3.1% 19.3% 10.0% -0.1% -1.5% 8.8% 9.4%

Railway network usage 4.4% 6.8% -4.3% -14.0% 2.6% -5.8% 5.0% 5.5%

Railway operation service to new HSRs 29.6% 41.4% 20.6% 27.1% 35.5% 49.8% 11.9% 10.0%

Other business 13.1% -0.5% 8.7% -7.9% 7.3% 5.0% 5.0% 5.0%

Total revenue 8.9% 2.7% 4.7% -6.3% 6.2% 10.5% 7.3% 7.1%

% of total

Intercity trains 18% 16% 15% 14% 14% 14% 13% 13%

Hong Kong through trains 3% 3% 3% 4% 3% 3% 3% 3%

Long-distance trains 34% 33% 33% 29% 27% 26% 25% 24%

Passenger transportation 55% 52% 51% 47% 44% 42% 41% 41%

Freight dispatched 3% 3% 3% 4% 4% 3% 3% 3%

Freight received 6% 6% 6% 6% 6% 6% 7% 7%

Other 0% 0% 1% 2% 1% 1% 1% 1%

Freight transportation 9% 9% 10% 12% 11% 10% 10% 10%

Railway network usage 22% 23% 21% 19% 19% 16% 16% 15%

Railway operation service to new HSRs 7% 9% 11% 15% 19% 25% 26% 27%

Other business 7% 7% 7% 7% 7% 7% 6% 6%

Total revenue 100% 100% 100% 100% 100% 100% 100% 100%

Guangshen Railway (525 HK)

Income statement and key assumptions

(RMB m, except for per share amount)

FY ended 31 Dec 1H14 2H14 1H15 2H15 1H16 2H16E 2013 2014 2015 2016E 2017E 2018E

Sales Revenue 7,168 7,633 7,375 8,350 8,079 9,292 Sales Revenue 15,801 14,801 15,725 17,371 18,647 19,965

Operating expense -6,617 -7,135 -6,590 -7,567 -7,165 -8,428 Operating expense -13,927 -13,752 -14,157 -15,593 -16,596 -17,667

Operating profit 551 498 785 784 914 865 Operating profit 1,873 1,049 1,569 1,778 2,052 2,298

Other gains and losses -92 -23 -152 -1 -26 -24 Other gains and losses -123 -115 -153 -50 -50 -50

Total EBIT 459 475 633 783 888 841 Total EBIT 1,750 934 1,416 1,728 2,002 2,248

Depreciation & Amortisation 710 720 721 691 715 787 Depreciation & Amortisation 1,414 1,429 1,412 1,502 1,533 1,550

EBITDA 1,168 1,195 1,354 1,474 1,603 1,628 EBITDA 3,164 2,363 2,828 3,230 3,534 3,797

Net finance costs -23 -36 19 15 13 37 Net finance costs -54 -58 34 50 44 39

Profits from associates and JCEs 1 4 1 1 6 6 Profits from associates and JCEs 5 5 2 12 13 13

Pre-Tax Profit 437 443 653 799 907 884 Pre-Tax Profit 1,702 881 1,452 1,791 2,058 2,300

Tax Expense -109 -111 -190 -198 -227 -220 Tax Expense -431 -220 -389 -448 -514 -575

Net Profit After Tax 329 332 463 600 680 663 Net Profit After Tax 1,271 661 1,063 1,343 1,543 1,725

Minority Interest 0 1 2 6 2 2 Minority Interest 3 1 8 4 4 4

Reported Earnings (attributable) 329 333 465 606 682 665 Reported Earnings 1,274 662 1,071 1,347 1,547 1,729

Adjusted Earnings 329 333 465 606 682 665 Adjusted Earnings 1,274 662 1,071 1,347 1,547 1,729

EPS (rep) 0.05 0.05 0.07 0.09 0.10 0.09 EPS (rep) 0.18 0.09 0.15 0.19 0.22 0.24

EPS (adj) 0.05 0.05 0.07 0.09 0.10 0.09 EPS (adj) 0.18 0.09 0.15 0.19 0.22 0.24

DPS 0.00 0.05 0.00 0.08 0.00 0.10 DPS 0.08 0.05 0.08 0.10 0.12 0.13

% YoY growth % YoY growth

Revenue -6.0% -6.6% 2.9% 9.4% 9.5% 11.3% Revenue 4.7% -6.3% 6.2% 10.5% 7.3% 7.1%

EBIT -48.6% -44.5% 37.9% 64.8% 40.2% 7.4% EBIT -1.8% -46.6% 51.6% 22.1% 15.8% 12.3%

Net profit -49.4% -46.7% 41.4% 81.8% 46.7% 9.7% Net profit -3.4% -48.0% 61.8% 25.8% 14.9% 11.8%

Margins and ratios Margins and ratios

EBITDA Margin 16.3% 15.7% 18.4% 17.6% 19.8% 17.5% EBITDA Margin 20.0% 16.0% 18.0% 18.6% 19.0% 19.0%

EBIT Margin 6.4% 6.2% 8.6% 9.4% 11.0% 9.0% EBIT Margin 11.1% 6.3% 9.0% 10.0% 10.7% 11.3%

Net Profit Margin 4.6% 4.4% 6.3% 7.3% 8.4% 7.2% Net Profit Margin 8.1% 4.5% 6.8% 7.8% 8.3% 8.7%

3

Key financials


Guangshen Railway (525 HK)

Balance sheet, cash flow statements and ratios


Balance sheet 2013 2014 2015 2016E 2017E 2018E Cash flow statement 2013 2014 2015 2016E 2017E 2018E

Cash 4,896 4,896 1,769 2,327 2,026 1,831 EBITDA 3,164 2,363 2,828 3,230 3,534 3,797

Trade and bill receivables 1,555 1,555 2,313 2,886 2,951 3,219 Net Interest Paid -54 -58 34 50 44 39

Inventories 392 392 401 307 342 409 Tax Paid -431 -220 -389 -448 -514 -575

Prepayments 74 244 190 143 183 255 Change in Working Cap -893 -116 -606 -296 -246 -213

Total current assets 6,917 7,088 4,673 5,663 5,502 5,714 Others 224 104 396 0 0 0

Operating Cash Flow 2,011 2,074 2,263 2,536 2,818 3,048

Long-term equity investment 196 142 147 169 181 193

PPE, net 24,841 24,846 24,581 24,643 24,651 25,172 Acquisitions -95 -140 -61 0 0 0

Other intangible assets 663 658 668 949 1,710 1,956 Capex -1,377 -1,000 -1,292 -2,271 -2,300 -1,600

Goodwill 281 281 281 281 281 281 Asset Sales 75 1 8 0 0 0

Long-term receivables 30 30 30 31 31 31 Others -304 4,385 -7 0 0 0

Deferred tax assets 91 91 68 93 93 93 Investing Cashflow -1,700 3,246 -1,352 -2,271 -2,300 -1,600

Other 43 97 89 115 115 115

Total non-current assets 26,144 26,144 25,864 26,281 27,062 27,842 Dividend (ordinary) -567 -567 -354 -567 -713 -819

Equity Raised 0 0 0 0 0 0

Total assets 33,061 33,232 30,537 31,943 32,563 33,556 Debt Movements 0 -3,500 0 0 0 0

Others -6 0 -1 0 0 0

Trade and bill payable 1,797 940 1,438 1,105 1,111 1,137 Financing Cashflow -573 -4,067 -355 -567 -713 -819

Short term Debt 3,493 3,493 0 0 0 0

Other payables and accruals 821 1,736 2,065 2,890 2,729 2,864 Exchange difference 0 0 0 0 0 0

Dividend payable 0 0 1 14 160 267 Net Chg in Cash/debt -262 1,252 556 -301 -195 629

Tax payable 330 270 158 314 314 314 FCF 310 5,319 910 266 518 1,448

Total current liabilities 6,440 6,439 3,661 4,324 4,314 4,581

2013 2014 2015 2016E 2017E 2018E

Long Term Debt 0 0 0 0 0 0 Valuation

Deferred tax liabilities 0 0 0 71 71 71 PE(x) 24.0 46.2 28.6 22.7 19.8 17.7

Other non-current liabilities 90 98 89 104 104 104 EPS growth (%) -3.4 -48.0 61.8 25.8 14.9 11.8

Total non-current liabilities 90 98 89 175 175 175 Yield(%) 1.9 1.2 1.9 2.3 2.7 3.0

PEG(%) -7.0 -1.0 0.5 0.9 1.3 1.5

Total liabilities 6,531 6,538 3,750 4,499 4,489 4,757 EV/EBITDA(x) 9.2 12.3 10.2 8.7 8.1 7.6

PB(x) 1.1 1.1 1.1 1.1 1.1 1.1

Shareholders Fund 26,651 26,651 26,746 27,462 28,097 28,825

Minority Interest 44 44 41 -18 -22 -26 Operational

Total S/H Equity 26,694 26,694 26,786 27,444 28,074 28,799 Revenue growth(%) 4.7 -6.3 6.2 10.5 7.3 7.1

EBIT margin(%) 11.1 6.3 9.0 10.0 10.7 11.3

Total Liab & S/H Fund 33,225 33,232 30,537 31,943 32,563 33,556 Net profit margin(%) 8.1 4.5 6.8 7.8 8.3 8.7

BVPS 3.76 3.76 3.78 3.88 3.97 4.07 Days receivables 32 40 53 64 65 65

EV 29,185 29,185 28,820 28,262 28,563 28,758 Days payables 79 69 82 97 92 86

Days inventories 11 10 11 8 8 9

Current ratio((x) 1.1 1.1 1.3 1.3 1.3 1.2

Quick ratio(x) 1.0 1.0 1.2 1.2 1.2 1.2

Asset/equity(x) 1.2 1.2 1.1 1.2 1.2 1.2

Net debt/equity(%) -5.3 -5.3 -6.6 -8.5 -7.2 -6.4

EBITDA interest coverage(x) 16.8 12.3 15.7 701.0 na na

ROE(%) 4.8 2.5 4.0 4.9 5.5 6.0

4

Earnings estimates and valuation

Positive earnings growth outlook

We initiate coverage on GSR with a Buy rating and target price of HK$5.81. We ex-pect the Company’s net profit to grow at a CAGR of 13.3% in 2016-2018. We expect traffic diversion to its passenger train service from HSR lines to largely stabilize. The Company introduced new passenger transportation services to offset the traffic de-cline from its competition with HSR lines. The introduction of new train services has also helped it improve passenger yield. Meanwhile, we expect gradual demand recov-ery in its freight business. The Company can also substantially expand the transporta-

tion services it offers to other HSR lines. We didn’t include any earnings impact from potential passenger tariff hikes. Our earnings sensitivity analysis shows that every 5ppt increase in its regular train passenger yield growth will boost our earn-ings forecast for the Company by >10% in 2017. Our earnings estimates for the Company in 2016-2018 are 2-4% above consensus estimates.

Figure 1: Earnings estimates: CGIS vs. consensus estimates (Rmb m, except for EPS)


Share price upside to be driven by passenger tariff hike

We initiate coverage on Guangshen Railway with a Buy rating and target price of HK$5.81, which suggest 19.0% upside potential. Our target price is based on a tar-get multiple of 23.5x 2017E PER. Historically, the Company has traded at average forward PER of 17.9x. Currently the stock trades at 19.8x 2017E PER.

We think a higher target multiple is justified for the Company. We believe CRC will raise passenger tariffs in 2017, which will drive a share price increase in 2017. The

current share price doesn’t fully reflect the positive earnings impact from ex-pected railway passenger tariff hikes. In the longer term, share price catalysts will also come from CRC’s deepening reform in areas of land resource development and likely asset injections. We don’t rule out the possibility that any other accelerat-ing CRC reform gestures will be upside catalysts in 2017.

2016E Sales EBIT EBITDA Net profit EPS Adj EPS GAAP

CGIS 17,371 1,728 3,230 1,347 0.19 0.19

Consensus 16,830 1,775 3,218 1,314 0.19 0.19

Diff% 3.2% -2.6% 0.4% 2.5% 2.8% 1.1%


CGIS 18,647 2,002 3,534 1,547 0.22 0.22

Consensus 17,865 2,035 3,519 1,504 0.22 0.22

Diff% 4.4% -1.7% 0.4% 2.9% 1.1% -0.7%


CGIS 19,965 2,248 3,797 1,729 0.24 0.24

Consensus 18,730 2,241 3,755 1,667 0.24 0.25

Diff% 6.6% 0.3% 1.1% 3.7% 0.0% -1.2%

5

Source: Company data, Bloomberg, CGIS Research estimates

Figure 2: Guangshen Railway H-share 12-mth forward PER


Figure 3: Guangshen Railway H-share 2016 performance

-20.0%

-15.0%

-10.0%

-5.0%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

Guangshen Railway HSI Index


Figure 4: Guangshen Railway H-share CYTD performance


Figure 5: Guangshen Railway A/H discount band

Guangshen Railway’s H-share price rose ahead of the central government’s working

conference in December 2016, which highlighted its new year’s focus on mixed-

ownership reform in industries such as railway, military, utility, and oil & gas. The

share price increased 4.7% YTD vs. 9.0% for the HSI YTD. Guangshen Railway’s H-

shares currently trade at a 20.2% discount to its A-shares. Historically, its average

A/H price discount has been around 26.7%. We don’t expect a further narrowing of

the A-H discount. We think the Company’s A and H shares will both respond posi-

tively to accelerating railway reform in areas of passenger tariff increases and land

resource redevelopment.

-2.0%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

Jan-17 Jan-17 Jan-17 Jan-17 Jan-17 Feb-17 Feb-17

Guangshen Railway HSI Index

-70.0%

-60.0%

-50.0%

-40.0%

-30.0%

-20.0%

-10.0%

0.0%

10.0%

20.0%

30.0%

A/H premium(discount) Average +1 Stdev -1 Stdev

0.0

5.0

10.0

15.0

20.0

25.0

30.0

35.0

40.0

12-mth forward PER Average +1 Std -1 Std

6

Traffic diversion from HSR lines is largely under

control We believe traffic diversion from its passenger business has largely stabilized. The

Company had to cancel a few train services due to competition with HSR lines, but it

introduced new train services thanks to an asset injection from its parent company.

For instance, the Company acquired the Sanmao Railway and Guangmeishan Rail-

way from its parent company, which should enable it to expand its passenger rail busi-

ness, adapt to market demand more effectively and improve its competitiveness.

The removal of the traffic diversion from its passenger business should help its reve-

nue growth recovery in 2016-2018. We expect passenger traffic on its intercity train

service to grow 1.0-1.5% per annum in 2016-2018. We forecast that passenger traffic

on its long-distance train service will grow 1.0% per annum in 2017-2018 after a 1.0%

passenger traffic decline in 2016. We expect passenger volume of its Hong Kong

through-train service to fall 10% YoY in 2016, as fewer Mainland tourists visit Hong

Kong. But we expect a gradual passenger traffic recovery in 2017-2018. We expect

passenger traffic on its Hong Kong through-train service to grow 2% per annum in

2017-2018.

With its new passenger train service, the Company can improve its passenger yield. In

addition, it can increase its high-speed train ticket prices without eroding its competi-

tiveness with other HSR lines. We expect the passenger yield of its passenger train

service to rise by 4-5% per annum in 2016-2018. We didn't include the positive impact

on its passenger yield from a likely passenger tariff hike. We believe a rise in the pas-

senger tariff is highly likely in 2017, which should further boost its revenue and earn-

ings growth recovery.

Figure 6: Guangshen Railway passenger volume and passenger yield forecast


Passenger volume (mn people) 2011 2012 2013 2014 2015 2016E 2017E 2018E 2016-2018 CAGR

Intercity trains 39 36 37 36 36 36 37 37 1.0%

Hong Kong through trains 4 4 4 4 4 3 3 4 2.0%

Long-distance trains 48 45 50 50 46 45 46 46 1.0%

Total 91 85 91 90 85 85 86 87 1.0%

% YoY

Intercity trains 5.7% -8.4% 3.3% -2.7% -0.9% 1.5% 1.0% 1.0%

Hong Kong through trains 18.4% 2.8% 3.9% 0.0% -3.2% -10.0% 2.0% 2.0%

Long-distance trains 7.2% -6.4% 11.1% 0.3% -8.6% -1.0% 1.0% 1.0%

Total 7.0% -6.9% 7.5% -0.9% -5.3% -0.4% 1.0% 1.0%

Passenger yield (Rmb/people)

Intercity trains 66.8 66.3 65.3 58.8 62.4 65.2 68.4 71.9 5.0%

Hong Kong through trains 125.9 127.6 127.5 134.7 134.9 155.1 162.9 171.0 5.0%

Long-distance trains 103.1 110.7 102.7 86.5 92.8 97.5 101.4 105.4 4.0%

Blended 88.4 92.7 88.6 77.6 82.0 86.0 89.8 93.8 4.4%

% YoY

Intercity trains 4.5% -0.6% -1.5% -10.0% 6.1% 4.5% 5.0% 5.0%

Hong Kong through trains -5.9% 1.4% -0.1% 5.7% 0.1% 15.0% 5.0% 5.0%

Long-distance trains 0.5% 7.4% -7.2% -15.8% 7.3% 5.0% 4.0% 4.0%

Blended 1.7% 4.9% -4.4% -12.5% 5.7% 5.0% 4.4% 4.4%

Passenger revenue (Rmb m)

Intercity trains 2,607 2,374 2,416 2,115 2,224 2,359 2,502 2,653 6.1%

Hong Kong through trains 461 480 498 527 510 528 566 606 7.1%

Long-distance trains 4,959 4,987 5,144 4,346 4,263 4,432 4,655 4,889 5.0%

Total 8,027 7,841 8,058 6,988 6,998 7,319 7,722 8,148 5.5%

% YoY

Intercity trains 10.4% -8.9% 1.8% -12.4% 5.2% 6.1% 6.1% 6.1%

Hong Kong through trains 11.4% 4.2% 3.8% 5.8% -3.1% 3.5% 7.1% 7.1%

Long-distance trains 7.8% 0.6% 3.1% -15.5% -1.9% 3.9% 5.0% 5.0%

Total 8.8% -2.3% 2.8% -13.3% 0.1% 4.6% 5.5% 5.5%

7

Freight business recovery to continue in 2017

Its freight business was only 10% of Guangshen Railway’s total revenue. The Compa-ny operates a freight transportation service between Shenzhen, Guangzhou and Ping-shi. The freight business faces demand weakness, led by 1) structural economic ad-justment in the Pearl River Delta region; and 2) intensified competition in the freight transportation market amid sluggish economic growth.

We expect a modest freight transportation volume recovery of 1.0-5.0% for Guangshen Railway in 2016-2018. The drivers for demand recovery are 1) the launch of freight services for non-bulk parcel delivery; and 2) an increase in rail’s share of the logistics transportation market. From 2H16, the central government has taken strong measures to resolve the overloading problem on highways. Also, railway transportation is more efficient and eco-friendly, which supports the government’s goal of reducing air pollu-tion and traffic congestion.

We expect CRC’s deepening freight business reform to help the Company expand its freight business. With freight volume recovery, we also expect freight yields to improve from 2017 onward. We forecast a freight yield decline of 3.3% in 2016, but we forecast a freight yield rise of 4.6% per annum in 2017-2018.

Figure 7: Guangshen Railway freight volume and freight yield forecast


Freight volume (mn ton) 2011 2012 2013 2014 2015 2016E 2017E 2018E 2016-2018 CAGR

Freight dispatched 22 21 20 18 17 16 17 17 3.0%

Freight received 46 41 39 33 32 33 35 37 5.0%

Total 69 63 60 52 48 49 51 54 4.3%

% YoY

Freight dispatched 6.5% -4.3% -4.8% -10.0% -7.8% -4.0% 2.0% 4.0%

Freight received -1.3% -10.9% -5.1% -15.2% -5.1% 5.0% 5.0% 5.0%

Total 1.1% -8.8% -5.0% -13.4% -6.1% 1.9% 4.0% 4.7%

Freight yield (Rmb/ton)

Freight dispatched 18.7 21.6 25.9 32.2 33.5 29.5 30.9 32.5 5.0%

Freight received 19.7 20.1 23.1 27.7 32.4 34.0 35.7 37.5 5.0%

Blended 20.2 21.4 26.9 34.2 36.4 35.2 36.8 38.5 4.6%

% YoY

Freight dispatched 15.2% 15.7% 20.0% 24.3% 3.9% -12.0% 5.0% 5.0%

Freight received 0.0% 2.2% 14.6% 20.0% 17.0% 5.0% 5.0% 5.0%

Blended 4.2% 6.3% 25.5% 27.1% 6.3% -3.3% 4.6% 4.6%

Freight revenue (Rmb m)

Freight dispatched 417 462 527 590 565 478 512 559 8.1%

Freight received 914 832 905 920 1,022 1,127 1,242 1,370 10.3%

Total 1,331 1,294 1,432 1,511 1,587 1,604 1,754 1,928 9.6%

% YoY

Freight dispatched 22.7% 10.7% 14.2% 12.0% -4.2% -15.5% 7.1% 9.2%

Freight received -1.3% -8.9% 8.8% 1.7% 11.1% 10.3% 10.3% 10.3%

Total 5.1% -2.8% 10.7% 5.5% 5.1% 1.1% 9.3% 9.9%

8

Transportation service business for HSR lines re-

mains on the fast track

The Company has benefited from HSR expansion in Guangdong province. It provides railway transportation services, other railway-related services, and entrusted railway transportation services to CRC. The revenue from its services to other HSR lines has grown faster than its traditional passenger business. Revenue from this segment start-ed in 2010 and grew at a CAGR of 31% in 2010-2015. This business segment repre-sented 19% of total revenue in 2015, rising from only 7% in 2010.

We expect revenue from this business segment to grow at a CAGR of 10.9% in 2016-2018, driven by increases in HSR train service density and new line additions. Based on the comprehensive service framework agreement the Company signed with CRC, the annual cap of its revenue from the services it provides to CRC will grow at a CAGR of >15% in 2016-2018.

Figure 8: Guangshen railway transportation-related service revenue progression


Revenue (Rmb m) 2014 2015 2016E 2017E 2018E 2016-2018 CAGR

Railway operation service 1,773 2,387 2,745 3,020 3,322 10.0%

Other transportation service 398 554 1,662 1,911 2,102 12.5%

Total 2,171 2,941 4,407 4,931 5,424 10.9%

% YoY

Railway operation service 28.1% 34.6% 15.0% 10.0% 10.0%

Other transportation service 22.7% 39.3% 200.0% 15.0% 10.0%

Total 27.1% 35.5% 49.8% 11.9% 10.0%

as % of total revenue

Railway operation service 12% 16% 17% 20% 21%

Other transportation service 3% 4% 11% 13% 13%

Total 15% 19% 28% 33% 34%

9

Share price upside from passenger tariff hike

Facing huge pressure from the fast development of the railway network, CRC and local governments will increasingly seek funding support from private investors. Ac-cordingly, improving the profitability of railway operations has become an urgent need for CRC and urban transit network operators to resolve funding issues.

We believe an increase in the passenger tariff is on the government agenda. The “Tentative Measures for the Supervision and Examination of Transport Cost Pricing for Normal Railway Passenger Trains”, which the NDRC released in December 2016, signalled a likely passenger tariff hike in the near term. The passenger tariff base-rate hike has been suspended since 1995. Currently, the railway base-rate is lower than that of airlines and highways. Our data shows that the passenger tariff for Guangshen Railway’s regular trains is only RMB0.11/person-km vs. RMB1.14/person-km and RMB0.31/person-km for airlines and highways, respectively. For high-speed trains, the passenger tariff for Guangshen and other HSR lines is around RMB0.50/person-km vs. RMB1.87km/person-km for Shinkansen, Japan’s HSR.

0.54

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GSR intercitytrain

GSR regulartrain

HSR trainservice (G)

Airline Highway Shinkansen


Figure 9: Passenger tariff comparison (Rmb/person-km)

Guangshen Railway will be a key beneficiary of a tariff hike, given that over 45% of its total revenue comes from passenger transportation. We didn’t include the earnings impact from passenger tariff hike to our earnings forecast for the company. Our base-case scenario assumes that its regular long-distance train passenger yield is to grow 4.0% YoY in 2017, led by new service introduction. We calculate that another 5ppt increase in our passenger yield assumption for its regular trains could boost our earn-ings estimate for the Company by >10% in 2017.

10

Figure 10: Guangshen Railway earnings’ sensitivity to passenger yield changes


Inter-city train 2017E net profitChange from base



20.0% 1,815 17.3% 34.8%

15.0% 1,726 11.5% 28.1%

10.0% 1,637 5.8% 21.5%

5.0% 1,547 0.0% 14.9%

0.0% 1,458 -5.8% 8.2%

-5.0% 1,369 -11.5% 1.6%

-10.0% 1,279 -17.3% -5.0%

HK-through train 2017E net profitChange from base



20.0% 1,608 3.9% 19.4%

15.0% 1,588 2.6% 17.9%

10.0% 1,568 1.3% 16.4%

5.0% 1,547 0.0% 14.9%

0.0% 1,527 -1.3% 13.4%

-5.0% 1,507 -2.6% 11.9%

-10.0% 1,487 -3.9% 10.4%

Long-distance train 2017E net profitChange from base



19.0% 2,051 32.5% 52.3%

14.0% 1,883 21.7% 39.8%

9.0% 1,715 10.8% 27.3%

4.0% 1,547 0.0% 14.9%

-1.0% 1,380 -10.8% 2.4%

-6.0% 1,212 -21.7% -10.0%

-11.0% 1,044 -32.5% -22.5%

11

Appendix

Company profile

Guangshen Railway provides mainly railroad passenger and freight transportation ser-vices. The Company also receives income from network usage of through passenger and freight trains, and the services it provides to new HSR lines.

The Company’s ultimate parent company is Guangzhou Railway (Group) Company (GRGC), which is under the jurisdiction of the China Railway Corporation (CRC). Guangshen Railway was formed in 1984 after it was separated from Guangzhou Rail-way Administration, becoming a state-owned enterprise administered by Guangzhou Railway Administration (the predecessor of CRGC). Guangshen Railway was listed on the New York Stock Exchange and the Hong Kong Stock Exchange in 1996. The Com-pany was listed on Shanghai Stock Exchange in 2006.

Major shareholders


Management profile

Mr. Wu Yong: Mr Wu, aged 52, is the chairman of the Board of the Company. Mr. Wu started his career in July 1986 and served in senior management in a few domestic railway divisions. In August 2014, Mr. Wu became the chairman and general manger of GRGC and deputy secretary of the party committee.

Mr. Hu Lingling: Mr. Hu, aged 52, became general manger of Guangshen Railway in December 2015. He has more than 30 years’ experience in the railway transportation industry.

Mr. Guo Xiangdong: Mr. Guo, aged 50, is the secretary of the Board of Guangshen Railway. Mr. Guo joined Guangshen Railway in 1991 and became the secretary of the Board in 2004.

GRGC, 37.1%

China Securities Finance

Corporation, 2.3%

Central Huijin Investment

Company, 1.2%

Other investors, 59.4%

1

CRSC [3969.HK]

BUY

Close: HK$6.20 (Feb 20, 2017)


Price Performance



Auditor Ernst & Young

Free Float 64.0%

52W range HK$3.79-6.55


Major Shareholding CRSC Corporation

(75.1%)


Kelly Zou—Analyst

(852) 3698-6319

[email protected]


(852) 3698-6317

[email protected]


China Railway Sector We initiate coverage of CRSC with a Buy rating and TP of HK$7.74. CRSC is our top pick in the railway equipment sector because of its high earnings visibility. The Company is involved in both early- and late-cycle railway investment. Even if new line addition slows down, CRSC can benefit from an increase in demand for its prod-ucts and services related to railway maintenance and operations. We expect its earnings to grow at a CAGR of 18.3% in 2016-2018. CRSC had RMB14bn in cash on hand at the end of 1H16, which was 29% of its market cap. It is likely to have some overseas M&A to enrich its technology and product offerings for long-term growth. We think the market underappreciates its uniqueness in the industry value chain and the fact that it is a system integrator, not just an equipment producer.


Early- and late-cycle railway investment to drive railway business growth. We

expect CRSC’s railway business revenue (63.5% of its total revenue in 2017E) to grow 15% p.a. in 2016-2018. CRSC provides control systems products and services for both early- and late-cycle railway investment. Even if early-cycle railway construction investment slows down, the Company can sustain revenue growth with its product and service offerings for late-cycle HSR operations. We estimate over 50% of its revenue is recurring revenue from rail control systems upgrades and replacements, which usually happen 8-10 years after its products are put into operation.

Urban transit business to outgrow its railway business. We expect CRSC’s

urban transit product and service (19.5% of its total revenue in 2017E) to grow faster than its railway business. We expect its urban transit business revenue to grow 30% per annum in 2016-2018. Apart from new line addition, China is pro-moting control system connectivity among different urban transit rail lines. We expect domestic companies like CRSC to gain market share from foreign com-panies, like Siemens and Alstom.

Overseas expansion and other business diversification to drive long-term

growth. We forecast that its overseas business revenue will grow at a CAGR of >17% in 2016-2018, driven by 1) railways’ “Go Overseas” strategy, and 2) CRSC’s penetration into other emerging markets with its experiences in railway “speed-up” projects. We forecast that its other business revenue will grow by 10-20% p.a. in 2016-2018, with growth from its sales expansion in areas like smart city and ultra high-speed wireless LAN technology.

BUY with a TP of HK$7.74: Our TP is based on a target multiple of 17x 2017E

PER, vs. its historical average of 13.3x PER. Currently, the stock trades at 13.5x 2017E PER. We think market underappreciates its uniqueness in the in-dustry value chain and the fact that it is a system integrator, not just an equip-ment producer.

INITIATE COVERAGE: Preferred rail-equipment stock with high earnings growth

February 21, 2017

Y/E Dec 31 2013 2014 2015 2016E 2017E 2018E

Turnover (RMB m) 13,065 17,329 23,952 29,187 34,136 40,002

Recurring net profit (RMB m) 1,260 2,033 2,496 3,026 3,563 4,232

Net margin (%) 9.6% 11.7% 10.4% 10.4% 10.4% 10.6%


% change 1.8% 49.2% 11.4% 6.4% 17.7% 18.8%

PER(x) 28.2 18.9 17.0 15.9 13.5 11.4

PBR(x) 3.8 3.3 2.6 2.2 2.0 2.6

EV/EBITDA(x) 22.2 12.1 9.6 7.7 6.3 6.1

0

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100

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200

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300

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400

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2

Key financials


Revenue breakdown (Rmb m) 2012 2013 2014 2015 2016E 2017E 2018E

Railway 8,741 10,280 13,642 15,703 18,843 21,670 24,921

Urban transit 1,696 1,985 1,929 3,930 5,109 6,641 8,634

Other business 0 457 1,181 3,802 4,562 5,018 5,520

Overseas business 114 343 577 517 672 807 928

Total 10,551 13,065 17,329 23,952 29,187 34,136 40,002

% of total

Railway 83% 79% 79% 66% 65% 63% 62%

Urban transit 16% 15% 11% 16% 18% 19% 22%

Other business 0% 3% 7% 16% 16% 15% 14%

Overseas business 1% 3% 3% 2% 2% 2% 2%

Total 100% 100% 100% 100% 100% 100% 100%

% YoY chg

Railway 17.6% 32.7% 15.1% 20.0% 15.0% 15.0%

Urban transit 17.0% -2.8% 103.7% 30.0% 30.0% 30.0%

Other business na 158.3% 221.9% 20.0% 10.0% 10.0%

Overseas business 199.8% 68.3% -10.3% 30.0% 20.0% 15.0%

Total 23.8% 32.6% 38.2% 21.9% 17.0% 17.2%

CRSC (3969 HK)



FY ended 31 Dec 1H14 2H14 1H15 2H15 1H16 2H16E P&L 2012 2013 2014 2015 2016E 2017E 2018E

Sales Revenue 8,467 8,862 11,760 12,192 14,347 14,840 Sales Revenue 10,551 13,065 17,329 23,952 29,187 34,136 40,002

COGS -6,323 -6,811 -8,773 -9,164 -10,586 -10,971 COGS -7,650 -9,625 -13,134 -17,937 -21,556 -25,162 -29,432

Gross profit 2,144 2,051 2,987 3,028 3,761 3,869 Gross profit 2,901 3,439 4,195 6,015 7,630 8,974 10,571

Selling and distribution costs -256 -203 -291 -355 -341 -388 Selling and distribution costs -296 -370 -459 -647 -730 -853 -1,000

Administrative expenses -1,031 -1,127 -1,307 -1,519 -1,483 -1,757 Administrative expenses -1,562 -1,706 -2,158 -2,827 -3,240 -3,789 -4,440

Other gains and losses 55 623 -6 499 -55 5 Other gains and losses 57 -59 678 494 -50 -50 -50

Total EBIT 912 1,343 1,383 1,653 1,882 1,728 Total EBIT 1,100 1,304 2,256 3,035 3,611 4,282 5,080

Depreciation & Amortisation 172 242 265 270 271 317 Depreciation & Amortisation 263 262 414 534 588 579 573

EBITDA 1,085 1,585 1,647 1,923 2,154 2,045 EBITDA 1,363 1,566 2,670 3,570 4,199 4,860 5,653

Net finance costs 20 14 28 16 73 65 Net finance costs -12 8 35 44 139 152 176

Profits from associates and JCEs 93 89 32 33 25 43 Profits from associates and JCEs 148 161 183 65 68 71 73

Pre-Tax Profit 1,026 1,447 1,442 1,702 1,981 1,837 Pre-Tax Profit 1,236 1,473 2,473 3,144 3,817 4,504 5,330

Tax Expense -181 -252 -253 -268 -314 -293 Tax Expense -149 -234 -433 -521 -607 -716 -847

Net Profit After Tax 845 1,195 1,189 1,434 1,666 1,544 Net Profit After Tax 1,087 1,239 2,040 2,623 3,210 3,788 4,482

Minority Interest -3 -4 -55 -73 -66 -118 Minority Interest -20 22 -6 -127 -184 -225 -250

Reported Earnings (attributable) 847 1,199 1,244 1,507 1,733 1,662 Reported Earnings (attributable) 1,068 1,260 2,033 2,496 3,026 3,563 4,232

Adjusted Earnings 847 1,199 1,244 1,507 1,733 1,662 Adjusted Earnings 1,068 1,260 2,033 2,496 3,026 3,563 4,232

EPS (rep) 0.12 0.17 0.16 0.16 0.18 0.16 EPS (rep) 0.19 0.19 0.29 0.32 0.34 0.41 0.48

EPS (adj) 0.12 0.17 0.16 0.16 0.18 0.16 EPS (adj) 0.19 0.19 0.29 0.32 0.34 0.41 0.48

DPS 0.00 0.58 0.00 0.03 0.00 0.07 DPS 0.06 0.04 0.58 0.03 0.07 0.08 0.10


Revenue 32.3% 33.0% 38.9% 37.6% 22.0% 21.7% Revenue 23.8% 32.6% 38.2% 21.9% 17.0% 17.2%

Gross profit 27.2% 16.9% 39.3% 47.7% 25.9% 27.8% Gross profit 18.6% 22.0% 43.4% 26.9% 17.6% 17.8%

EBIT 42.8% 102.0% 51.5% 23.0% 36.2% 4.6% EBIT 18.6% 73.0% 34.6% 19.0% 18.6% 18.7%

Net profit 42.1% 93.1% 46.8% 25.7% 39.3% 10.3% Net profit 18.1% 61.3% 22.8% 21.2% 17.7% 18.8%


Gross profit margin 25.3% 23.1% 25.4% 24.8% 26.2% 26.1% Gross profit margin 27.5% 26.3% 24.2% 25.1% 26.1% 26.3% 26.4%

EBITDA Margin 12.8% 17.9% 14.0% 15.8% 15.0% 13.8% EBITDA Margin 12.9% 12.0% 15.4% 14.9% 14.4% 14.2% 14.1%

EBIT Margin 10.8% 15.2% 11.8% 13.6% 13.1% 11.6% EBIT Margin 10.4% 10.0% 13.0% 12.7% 12.4% 12.5% 12.7%

Net Profit Margin 10.0% 13.5% 10.6% 12.4% 12.1% 11.2% Net Profit Margin 10.1% 9.6% 11.7% 10.4% 10.4% 10.4% 10.6%

3

Key financials


CRSC (3969 HK) Price: 6.20



Balance sheet 2012 2013 2014 2015 2016E 2017E 2018E Cash flow statement 2012 2013 2014 2015 2016E 2017E 2018E

Cash 2,652 3,974 6,346 14,340 16,456 18,489 14,340 EBITDA 1,363 1,566 2,670 3,570 4,199 4,860 5,653

Trade and bill receivables 4,376 5,998 7,324 8,285 9,995 11,784 8,285 Net Interest Paid -12 8 35 44 139 152 176

Inventories 2,031 2,048 2,861 2,689 2,362 2,895 2,689 Tax Paid -225 -230 -327 -523 -607 -716 -847

Prepayments 658 1,068 1,960 2,466 2,799 3,273 2,466 Change in Working Cap -477 101 -648 -9 -868 -976 -1,157

Amounts due from contract customers 2,030 2,306 3,111 5,905 8,172 10,241 5,905 Others 19 114 -530 -314 -197 -186 -221

Other current assets 141 1,242 225 288 287 285 288 Operating Cash Flow 667 1,559 1,199 2,768 2,666 3,134 3,604

Total current assets 11,888 16,635 21,827 33,973 40,071 46,968 33,973

Acquisitions 0 -586 644 -116 0 0 0

Long-term equity investment 773 867 344 423 491 561 423 Capex -615 -553 -1,434 -946 -560 -545 -545

PPE, net 2,167 1,675 2,750 3,105 3,202 3,288 3,105 Asset Sales 5 15 21 3 0 0 0

Other intangible assets 294 161 689 589 498 426 589 Others -321 -244 2,250 -2,016 0 0 0

Goodwill 0 0 237 267 267 267 267 Investing Cashflow -932 -1,368 1,481 -3,075 -560 -545 -545

Prepaid land lease payments 1,610 1,314 2,012 2,278 2,245 2,198 2,278

Deferred tax assets 154 153 115 147 147 147 147

Trade receivables 188 313 596 936 1,140 1,334 936 Dividend (ordinary) -19 -151 0 -3,305 -220 -605 -713

Other non-current assets 10 527 7 275 275 275 275 Equity Raised 0 1,418 0 8,907 0 0 0

Total non-current assets 5,196 5,011 6,750 8,020 8,265 8,496 8,020 Debt Movements -131 -534 66 150 230 50 50

Others -84 -4 1 0 0 0 0

Total assets 17,084 21,645 28,577 41,992 48,336 55,465 41,992 Financing Cashflow -235 728 67 5,751 10 -555 -663

Trade and bill payable 4,019 5,244 6,986 10,954 13,165 15,304 10,954 Exchange difference 1 -1 -1 58 0 0 0

Short term Debt 492 234 228 429 469 469 429 Net Chg in Cash/debt -499 919 2,746 5,502 2,116 2,034 2,396

Other payables and accruals 1,835 2,760 4,417 5,501 6,611 7,717 5,501

Amounts due to contract customers 1,792 2,269 3,136 3,999 3,794 4,438 3,999 FCF -265 191 2,680 -307 2,106 2,589 3,059

Provision 0 0 0 35 35 35 35

Tax payable 48 42 144 191 191 191 191 2012 2013 2014 2015 2016E 2017E 2018E

Other current liabilities 114 89 84 83 83 83 83 Valuation

Total current liabilities 8,299 10,638 14,994 21,193 24,349 28,238 21,193 PE(x) 28.7 28.2 18.9 17.0 15.9 13.5 11.4

EPS growth (%) 18.1 61.3 22.8 21.2 17.7 18.8

Long Term Debt 194 118 90 38 228 278 38 Yield(%) 1.0 0.7 10.6 0.5 1.3 1.5 1.8

Deferred tax liabilities 0 0 89 74 74 74 74 PEG(%) 1.6 0.3 0.7 0.8 0.8 0.6

Provision 230 152 105 123 123 123 123 EV/EBITDA(x) 16.7 22.2 12.1 9.6 7.7 6.3 6.1

Long-term payables 60 69 75 34 41 48 34 PB(x) 3.3 3.8 3.3 2.6 2.2 2.0 2.6

Defined benefit obligations 590 550 619 682 682 682 682

Other non-current liabilities 68 119 130 113 113 113 113

Total non-current liabilities 1,143 1,009 1,107 1,064 1,261 1,318 1,064 Operational

Revenue growth(%) 23.8% 32.6% 38.2% 21.9% 17.0% 17.2%

Total liabilities 9,442 11,646 16,101 22,257 25,610 29,556 22,257 EBIT margin(%) 18.6% 73.0% 34.6% 19.0% 18.6% 18.7%

Net profit margin(%) 18.1% 61.3% 22.8% 21.2% 17.7% 18.8%

Shareholders Fund 7,597 9,982 11,664 18,843 21,650 24,607 18,843

Minority Interest 45 17 812 892 1,076 1,301 892 Days receivables 197 196 164 160 161 162

Total S/H Equity 7,642 9,999 12,475 19,735 22,726 25,909 19,735 Days payables 304 317 335 335 334 333

Days inventories 78 80 55 40 42 44

Total Liab & S/H Fund 17,084 21,645 28,577 41,992 48,336 55,465 41,992

Current ratio((x) 1.4 1.6 1.5 1.6 1.6 1.7 1.6

Quick ratio(x) 1.2 1.4 1.3 1.5 1.5 1.6 1.5

EV 22,736 34,804 32,398 34,379 32,493 30,510 34,379 Asset/equity(x) 2.2 2.2 2.5 2.2 2.2 2.3 2.2

BVPS 1.69 1.43 1.67 2.14 2.46 2.80 2.14 Net debt/equity(%) Net cash Net cash Net cash Net cash Net cash Net cash Net cash

EBITDA interest coverage(x) 40.3 71.2 54.2 37.4 19.5 19.7 20.3

ROE(%) 14.1 12.6 17.4 13.2 14.0 14.5 22.5

4

Earnings outlook

High earnings growth visibility

We initiative coverage on CRSC with a Buy rating and a target price of HK$7.74. CRSC is our preferred stock in the railway equipment sector because of its high earn-ings growth visibility. The Company is involved in both early- and late-cycle railway investment. Even if new line addition slows down, CRSC will benefit from increased demand for its products and services related to railway maintenance and operations. We estimate that over 50% of its revenue is recurring revenue from upgrades and replacements, which should help sustain its business growth. Overall, we expect its net profit to grow at a CAGR of 18.3% in 2016-2018. Our earnings estimates for the Company are largely in line with consensus.



Preferred stock in the rail equipment sector in the HK market

We initiate our coverage on CRSC with a Buy rating and target price of HK$7.74, which implies 24.8% upside potential. Our TP is based on a target multiple of 17.0x 2017E PER. Historically, the stock has traded at 13.3x PER. Currently, the stock is trading at 13.5x 2017E PER.

We believe CRSC deserves a higher valuation than CRRC or CRRC Times Electric, considering its faster earnings growth in 2017. We forecast that CRSC’s net profit will grow 17.7% YoY in 2017. We expect CRRC’s net profit to remain largely flat YoY in 2017, while we expect CRRC Times Electric’s net profit to grow 10.9% YoY in 2017.

We think market underappreciates CRSC’s uniqueness in the rail investment value chain and the fact that it is a systems integrator, not just an equipment producer. Since it was listed on the Hong Kong Stock Exchange (HKEx) in 2015, the market incorrectly put it into the same category as CRRC and CRRC Times Electric. As the market was worried about weakening railway equipment demand in 2016, CRSC’s share price has been under pressure since it was listed on the HKEx in 2H15.


CGIS 29,187 3,611 4,199 3,026 0.34 0.34

Consensus 29,165 3,593 4,125 3,038 0.35 0.35

Diff% 0.1% 0.5% 1.8% -0.4% -1.6% -0.5%


CGIS 34,136 4,282 4,860 3,563 0.41 0.41

Consensus 34,425 4,122 4,792 3,540 0.41 0.40

Diff% -0.8% 3.9% 1.4% 0.6% -0.9% 1.3%


CGIS 40,002 5,080 5,653 4,232 0.48 0.48

Consensus 39,775 4,722 5,474 4,051 0.47 0.46

Diff% 0.6% 7.6% 3.3% 4.5% 3.3% 5.4%

5


Figure 2: CRSC12-mth forward PER

CRSC’s share price outperformed the HSI Index in 2016 due to higher-than-expected railway investment. The stock has risen 11.3% YTD, vs. HSI Index rose 9.0% YTD. We expect improving market sentiment towards the railway equipment sector to support share price upside in the coming months. Also, the stock is one of the selected stocks in Shenzhen-Hong Kong Stock Connect. Giv-en its uniqueness in the railway investment value chain and attractive valuation compared to its A-share peers, we expect fund flows from the Mainland to drive share price upside.


Figure 3: CRSC 2016 share price performance


Figure 4: CRSC CYTD share price performance

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5

Sep

-15

Oct

-15

No

v-1

5

De

c-1

5

Jan

-16

Feb

-16

Mar

-16

Ap

r-1

6

May

-16

Jun

-16

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16

Au

g-1

6

Sep

-16

Oct

-16

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v-1

6

De

c-1

6

Jan

-17

Feb

-17


-4.0%

-2.0%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%


CRSC HSI Index

6

Sustainable railway business growth in 2017

CRSC is the leading market player in China’s rail transportation control systems mar-ket. It has over a 65% and 40% market share, respectively, in high-speed railway and urban transit control systems in China, as it is the only one-stop systems provider in the world, covering design, integration, equipment manufacturing and installation.

The Company is a key beneficiary of the fast development of railway and urban transit networks in China. It provides control systems products and services related to both early- and late-cycle railway investment. Even if early-cycle railway construction invest-ment slows down, the Company can sustain revenue growth with the products and services it offers for late-cycle railway investment needs. In addition, rail transportation control systems are crucial for train operation safety and efficiency. So the Company will also benefit from railway spending on control systems replacement.

Overall, we expect its rail control systems product and service revenue to grow at a CAGR of 15% in 2016-2018. We expect the growth to come mainly from rising HSR operation density and increasing railway operation demand for control systems.

The industry trend is also shifting from the traditional method of separating bidding of heavy-current projects and light-current projects to general contracting of integrated tender projects. With its acquisition of two railway electrification companies in Zheng-zhou and Changsha, CRSC should be able to enhance its general contracting capabil-ity, so we expect it to further gain market share for its rail control system business.

We expect urban transit network investment to grow faster than HSR railway invest-ment, which should enable CRSC’s urban transit products and services to grow faster than its railway business. We forecast that its urban transit business revenue will grow 30% per annum in 2016-2018. Apart from new line addition, China is promoting control systems connectivity among urban transit rail lines. We expect domestic companies like CRSC is to gain market share from foreign companies, such as Siemens and Al-stom. As the market leader and industry standard designer, CRSC should be able to further expand its market share by replacing foreign imports of railway control systems.

Source: Bloomberg, CGIHK Research


Figure 5: Railway business sales progression


Figure 6: Urban transit business sales progression

0.0%

5.0%

10.0%

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30.0%

35.0%

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2013 2014 2015 2016E 2017E 2018E

Turnover (Rmb m) % YoY chg (rhs)

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2013 2014 2015 2016E 2017E 2018E

Turnove (Rmb m) % YoY chg (rhs)

Railway business to account for 63.5%

of its total revenue in 2017E

Urban transit business to account for

19.5% of its total revenue in 2017E

7

Overseas expansion and new business diversifi-

cation for long-term growth

CRSC has been developing its overseas business. We forecast that its overseas busi-ness revenue will grow at a CAGR of 17.5% in 2016-2018. CRSC has experience providing products and services to over 10 countries and regions, including Angola, Argentina, Pakistan, Laos and Vietnam. It aims to establish overseas marketing, sales and service networks, develop innovative overseas business models, build an interna-tional talent pool, and accelerate its expansion in overseas markets. It is considering M&A, joint ventures, cooperation or overseas investment to expand its overseas busi-ness.

CRSC can expand its overseas business in two ways: (1) forming a consortium with construction and rolling stock companies; or (2) expanding overseas on its own. The Company has product and technology know-how that helped speed up the develop-ment of China’s railway network in the 2000s. With increasing demand from overseas markets for railway network acceleration, the Company can penetrate overseas mar-kets like India and Pakistan.

CRSC also has other businesses in the fields of municipal engineering and related construction services, and commodities trading. We forecast that its other business revenue will grow at a CAGR of 10% in 2016-2018, with growth coming from sales expansion in areas like smart city and ultra high-speed wireless LAN technology.



Figure 7: Overseas business sales progression


Figure 8: Other business sales progression

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2013 2014 2015 2016E 2017E 2018E


8

The market underappreciates its uniqueness and

strength in the railway equipment sector

The Company specializes in R&D of rail transportation control systems. It is the au-thorized reviewer of rail transportation control system equipment modes, technology standards and product standards. It also has the widest product coverage on existing railways, which enables it to build a world-leading case database for its product R&D.

The Company is the most experienced industry player in the rail transportation control systems market. It is the only supplier of rail control systems that has participated in the construction of all of China’s major HSR projects, as well as all six speed-up pro-jects on old railway lines. Its control systems cover >80% of national HSR lines, ensur-ing its dominant position in China’s rail transportation control systems market.



Figure 9: Market share of HSR control systems (2011-2014)


Figure 10: Market share of urban transit control systems (2011-2014)

CRSC, 40.1%

Thales SAIC, 14.6%

Beijing Traffic Control

Technology, 11.8%

CREC, 5.4%

FiberHome Technologies,

4.1%

ZET Corporation,

3.9%

others, 20.1%

CRSC dominates the rail control system market in China. In this market, CRSC should be compared to CRCC (1186 HK, 601186 CH) and CREC, a subsidiary under CRG (390 HK, 601390 CH), where market share is calculated based on control system pro-ject wins. Industry data suggests that at the end of 2014, CRSC had a 65% share of the railway control systems market in terms of the cumulative contracted mileage of completed integration projects the Company undertook. CRCC and CREC had market shares of 32.5% and 2.3%, respectively. If we calculate market share based on control systems sales, CRSC actually has over 80% of the high-speed railway control systems market.

In the urban transit control systems market, CRSC is also ranked No 1, with a 40% market share in terms of cumulative contract value won between 2011 and 2014. The No 2 and No 3 industry players are Thales SAIC Transportation Systems and Beijing Traffic Control Technology, which had a 15% and 12% market share, respectively, in the same period. CRRC Times Electric is a new market entrant, supplying its first con-trol system product to Changsha’s No 2 metro line in 2014.

CRSC, 65.2%

CRCC, 32.5%

CREC, 2.3%

9


It is also one of only a few companies certified to manufacture core signaling system products for rail transportation. It is one of only three companies certified for general contracting of railway heavy-current projects (electric power projects and electrification projects) and light-current projects (signaling projects and communication projects).

The industry trend is shifting away from the traditional method of separating bidding of heavy-current projects and light-current projects, to general contracting of integrated tender projects. Companies with heavy-current and light-current project integration capacity are therefore more likely to win general contracts for integrated tendering

projects.


Figure 11: CRSC’s unique “3 in 1” business model

The market incorrectly put the Company in the same category as Hollysys (HOLI US) and CRRC Times Electric. Although CRSC competes with Hollysys and CRRC Times Electric in certain product or system categories, CRSC is more advanced than the other two companies in terms of product coverage and system-integration capability.


Figure 12: Rail control system

Hollysys

10


With its unique position in the railway investment value chain, CRSC enjoys faster revenue and earnings growth than its peers. It has seen faster growth than CRCC and CRG, two railway construction companies, and it has enjoyed faster revenue and earn-ings growth than Hollysys and CRRC Times Electric. With its business mix related to both early- and late-cycle railway investment, the Company’s net profit margin and ROE are between those of the railway construction companies and those of equipment producers.


Figure 13: Growth and profitability comparison between CRRC and its competitors

Ticker 2011 2012 2013 2014 2015 2011 2012 2013 2014 2015 2011 2012 2013 2014 2015 2011 2012 2013 2014 2015

CRCC 1186 HK -2.8% 6.0% 21.3% 0.9% 1.3% 1.8% 1.8% 1.8% 2.0% 2.2% 88.2% 9.4% 20.0% 13.1% 3.2% 12.9% 12.6% 13.5% 13.5% 12.4%

CRG 390 HK -3.1% 5.3% 16.1% 9.2% 1.7% 1.5% 1.6% 1.7% 1.8% 2.0% -9.5% 10.5% 26.8% 9.5% 10.0% 9.6% 9.9% 11.4% 11.3% 10.9%

CRSC 3969 HK na na 23.8% 32.6% 38.2% na 10.1% 9.6% 11.7% 10.4% na na 28.8% 12.5% 41.4% na na 14.3% 18.8% 16.4%

CRCC 1766 HK 24.0% 12.0% 9.7% 123.7% 8.9% 4.9% 4.5% 4.3% 5.0% 5.0% 53.1% -8.3% 0.3% 36.7% 4.9% 18.5% 14.5% 11.9% 17.1% 12.7%

CRRC Times Electric 3898 HK 21.4% 1.5% 22.2% 43.2% 11.7% 16.7% 17.0% 16.7% 19.0% 21.1% 38.0% 3.7% 17.7% 53.4% 23.5% 24.4% 21.3% 19.3% 23.9% 24.2%

Hollysys HOLI US 51.0% 22.4% 8.5% 49.4% 1.9% 15.6% 17.4% 14.9% 13.4% 18.3% 52.0% 32.9% -7.9% 29.0% 37.5% 17.4% 18.6% 13.8% 15.4% 18.1%

Revenue NPT margin EPS growth ROE

11

Appendix

Company profile

CRSC specializes in providing rail transportation control systems and services in China for rail operation safety and efficiency. Its history can be traced back to 1953, when the Signal & Communication Engineering Company and Signal & Communication Design Institute, the predecessors of CRSCD (its principal subsidiary), were established by the MOR. In 1981, MOR approved the establishment of CRSC Corporation Group, its con-trolling shareholder. CRSC Corporation Group remained a wholly state-owned enter-

prise supervised by SASAC until 2010. In December 2010, CRSC was established as a joint stock company with the reorganization of its controlling shareholder, required by SASAC. CSRC Corporation Group injected the assets related to its rail transportation control systems business into CRSC accordingly. CSRC was listed in Hong Kong in August 2015.

Major shareholders


Management profile

Mr. Zhou Zhiliang: Mr. Zhou, aged 50, is chairman of the Board of CRSC, a position he assumed in Jan 2012. Mr. Zhou has been general manager of CRSC Corporation Group since Jan 2012. He was a vice president of CRCC (1186 HK, 601186 CH) from 2007 to 2012. From Dec 2004 to Oct 2007, Mr. Zhou was a deputy general manager of China Railway Construction Corp.

Mr. Yin Gang: Mr. Yin, aged 52, has been president of the Company since May 2015. He is responsible mainly for overseeing the management of CRSC’s daily production and operations. Mr. Yin was a vice president of CRSC between Dec 2010 and May 2015, and was also chairman of CRSCD from Jan 2012 to Nov 2012 and Board secre-tary of CRSC from Apr 2011 to May 2013. From Aug 2001 to May 2015, Mr. Yin was deputy general manager of CRSC Corporation Group.

Mr. Hu Shaofeng: Mr. Hu, aged 50, has been Company secretary since May 2013. He served as deputy general manager, chief accountant and general counsel of China Railway Construction Heavy Industry Co., Ltd. from 2011 to 2012. Mr. Hu served as chief accountant of China Railway Track Systems Group Co., Ltd. from 2007 to 2011.

CRSC Corporation

Group, 75.1%

China Shipping (Group)

Company, 1.4%

Shanghai Zhenghua Port

Machinery, 1.4%

National Council for

Social Security

Fund, 2.0%

CRG, 1.40%

Other H-share holders, 18.6%

1

CRRC [1766.HK]

Hold

Close: HK$7.46 (Feb 20, 2017)


Price Performance



Auditor Deloitte

Free Float 94.0%

52W range HK$6.45-8.35


Major Shareholding CRCCG (54.2%)


Kelly Zou—Analyst

(852) 3698-6319

[email protected]


(852) 3698-6317

[email protected]


China Railway Sector We initiate coverage on CRRC with a Hold rating and a target price of HK$7.72, which implies 3.5% upside potential. We believe its share price re-rating will still be constrained by slow earnings growth recovery in 2017. With declining locomotive and MU sales, we expect its earnings growth to be dampened in 2016 and 2017. While MU maintenance revenue accounts for only ~10% of its total revenue, we expect the growth recovery from increasing railway operations and maintenance spending to drive slower earnings growth than for CRSC or CRRC Times Electric. We expect its earnings to remain flattish in 2016 and 2017, with earnings growth recovery only in 2018.


Core business recovery to dampen in 2017. With slow locomotive and MU

sales recovery, we expect earnings growth to be dampened in 2016 and 2017. We forecast that its revenue will remain largely flat YoY in 2016 and 2017. Since MU maintenance revenue accounts for ~10% of CRRC’s total revenue, we don’t expect rising maintenance revenue to fully offset falling newly built MU product revenue in 2017. New line addition, increasing HSR train density and rising maintenance demand will drive business growth recovery from 2018 on. We expect its revenue to grow 11.3% YoY in 2018.

Urban transit business and new business growth to continue. We expect

its urban transit business revenue to grow by 20% p.a. in 2016-2018. As at the end of 9M16, the order backlog for its urban transit vehicle business stood at RMB106.9bn, equivalent to 4.4x of its urban transit business revenue in 2015. CRRC has expanded its business into the new energy and environmental pro-tection equipment industries. We forecast that its new business revenue will grow by 10-15% p.a. in 2016-2018.

Margin expansion due to post-merger cost savings. We expect its gross

profit margin to expand from 19.6% in 2015 to 20.3% in 2016. Even with chang-es in product mix, we expect its gross profit margin to largely stabilize at around 20% in 2017-2018. We also expect cost savings in SG&A. After factoring in oth-er losses, we expect its operating profit margin to stabilize at 7.4-7.5% in 2016-2018.

HOLD with a TP of HK$7.72. We set our TP at HK$7.72 and give CRRC a

Hold rating. Our TP is based on a target multiple of 16x 2017E PER and sug-gests 3.5% upside potential. Historically, the stock has traded at an average PER of 18.6x. Given the subdued EPS growth in 2017, we believe a lower tar-get PER multiple is appropriate.

INITIATE COVERAGE: Earnings to remain subdued in 2017

February 21, 2017

Y/E Dec 31 2013 2014 2015 2016E 2017E 2018E

Turnover (RMB m) 96,525 218,451 237,785 242,311 249,659 277,982


Net margin (%) 4.3% 5.0% 5.0% 5.0% 4.9% 5.0%


% change 0.2% na 5.9% 2.2% -3.1% 12.3%

PER(x) 22.0 16.1 15.2 14.9 15.4 13.7

PBR(x) 2.5 1.0 1.9 1.7 1.5 1.4

EV/EBITDA(x) 11.0 4.2 7.4 6.7 6.3 5.5

0

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16

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-17

Fe

b-1

7


2

Key financials


Revenue breakdown (Rmb m) 2014 2015 2016E 2017E 2018E

Locomotives 36,217 32,361 22,653 31,714 34,885

Passenger carriages 11,367 10,227 11,761 11,761 11,761

Freight wagons 14,780 10,138 7,097 9,462 10,408

Multiple units 63,450 76,824 86,043 64,532 71,994

Railway equipment 125,814 129,550 127,553 117,469 129,048

Rapid transit vehicles and urban infrastructure17,931 24,477 29,373 35,247 42,297

New business 40,984 52,513 60,390 69,448 76,393

Modern service 33,722 31,244 24,995 27,495 30,244

Total revenue 218,451 237,784 242,311 249,659 277,982

% YoY

Locomotives na -10.6% -30.0% 40.0% 10.0%

Passenger carriages na -10.0% 15.0% 0.0% 0.0%

Freight wagons na -31.4% -30.0% 33.3% 10.0%

Multiple units na 21.1% 12.0% -25.0% 11.6%

Railway equipment na 3.0% -1.5% -7.9% 9.9%

Rapid transit vehicles and urban infrastructure na 36.5% 20.0% 20.0% 20.0%

New businesses na 28.1% 15.0% 15.0% 10.0%

Modern service na -7.3% -20.0% 10.0% 10.0%

Total revenue na 8.9% 1.9% 3.0% 11.3%

% of total

Locomotives 17% 14% 9% 13% 13%

Passenger carriages 5% 4% 5% 5% 4%

Freight wagons 7% 4% 3% 4% 4%

Multiple units 29% 32% 36% 26% 26%

Railway equipment 58% 54% 53% 47% 46%

Rapid transit vehicles and urban infrastructure 8% 10% 12% 14% 15%

New businesses 19% 22% 25% 28% 27%

Modern service 15% 13% 10% 11% 11%

Total revenue 100% 100% 100% 100% 100%

CRRC (1776 HK)



Interim 1H14 2H14 1H15 2H15 1H16 2H16E P&L 2014 2015 2016E 2017E 2018E

Sales Revenue 86,410 132,040 91,816 145,968 92,321 149,990 Sales Revenue 218,451 237,785 242,311 249,659 277,982

COGS -69,762 -105,858 -72,310 -118,940 -71,679 -121,538 COGS -175,620 -191,250 -193,217 -199,760 -222,550

Gross Profit 16,648 26,183 19,507 27,028 20,642 28,452 Gross Profit 42,831 46,535 49,094 49,899 55,432

Selling and distribution costs -2,436 -4,966 -3,372 -4,581 -3,179 -4,818 Selling and distribution costs -7,402 -7,954 -7,996 -7,989 -8,617

Administrative expenses -7,742 -11,985 -9,533 -12,953 -9,987 -13,275 Administrative expenses -19,727 -22,486 -23,262 -23,718 -26,408

Other gains and losses 164 -254 507 876 202 169 Other gains and losses -90 1,383 371 378 386

Total EBIT 6,634 8,978 7,108 10,370 7,678 10,529 Total EBIT 15,612 17,478 18,207 18,571 20,793

Depreciation & Amortisation 2,416 2,827 2,816 3,401 3,079 3,873 Depreciation 5,244 6,217 6,952 6,919 6,939

EBITDA 9,050 11,805 9,924 13,771 10,757 14,402 EBITDA 20,856 23,695 25,159 25,490 27,732

Net Interest Income -818 -1,044 -313 -535 -454 -387 Net Interest Expense -1,862 -849 -841 -956 -945

Profit contribution from JV and associate 315 418 209 210 333 327 Share of Associate Profit (loss) 734 419 660 726 799

Pre-Tax Profit 6,131 8,352 7,004 10,044 7,557 10,468 Pre-Tax Profit 14,484 17,048 18,026 18,341 20,646

Tax Expense -1,108 -1,029 -1,329 -1,621 -1,483 -2,050 Tax Expense -2,137 -2,951 -3,533 -3,595 -4,047

Net Profit After Tax 5,023 7,323 5,675 8,423 6,074 8,418 Net Profit After Tax 12,346 14,098 14,493 14,746 16,599

Minority Interest -626 -905 -976 -1,304 -1,280 -1,131 Minority Interest -1,531 -2,279 -2,410 -2,452 -2,760

Reported Earnings (attributable) 4,398 6,418 4,699 7,120 4,795 7,288 Reported Earnings 10,815 11,818 12,082 12,294 13,839

Adjusted Earnings 4,398 6,418 4,699 7,120 4,795 7,288 Adjusted Earnings 10,815 11,818 12,082 12,294 13,839

EPS (rep) 0.17 0.24 0.17 0.26 0.18 0.27 EPS (rep) 0.41 0.43 0.44 0.43 0.48

EPS (adj) 0.17 0.24 0.17 0.26 0.18 0.27 EPS (adj) 0.41 0.43 0.44 0.43 0.48

DPS 0.00 0.00 0.00 0.15 0.00 0.15 DPS 0.00 0.15 0.15 0.15 0.17


Revenue 137.1% 119.8% 6.3% 10.5% 0.5% 2.8% Revenue 126.3% 8.9% 1.9% 3.0% 11.3%

Gross profit 172.4% 148.9% 17.2% 3.2% 5.8% 5.3% Gross profit 157.6% 8.6% 5.5% 1.6% 11.1%

EBIT 235.6% 124.2% 7.2% 15.5% 8.0% 1.5% EBIT 161.0% 12.0% 4.2% 2.0% 12.0%

Net profit 200.9% 139.6% 6.9% 10.9% 2.0% 2.4% Net profit 161.2% 9.3% 2.2% 1.8% 12.6%


Gross profit margin 19.3% 19.8% 21.2% 18.5% 22.4% 19.0% Gross profit margin 19.6% 19.6% 20.3% 20.0% 19.9%

EBITDA Margin 10.5% 8.9% 10.8% 9.4% 11.7% 9.6% EBITDA Margin 9.5% 10.0% 10.4% 10.2% 10.0%

EBIT Margin 7.7% 6.8% 7.7% 7.1% 8.3% 7.0% EBIT Margin 7.1% 7.4% 7.5% 7.4% 7.5%

Net Profit Margin 5.1% 4.9% 5.1% 4.9% 5.2% 4.9% Net Profit Margin 5.0% 5.0% 5.0% 4.9% 5.0%

3

Key financials


CRRC (1776 HK)



Balance sheet 2014 2015 2016E 2017E 2018E Cash flow statement 2014 2015 2016E 2017E 2018E

Inventories 59,628 59,747 68,817 73,336 81,703 EBITDA 20,856 23,695 25,159 25,490 27,732

Trade receivables 58,424 72,514 86,302 88,920 99,007 Tax Paid -2,878 -3,328 -3,533 -3,595 -4,047

Bills receivables 8,880 10,166 9,705 9,999 11,133 Change in Working Cap 7,995 -7,001 -4,973 -2,464 -2,261

Prepayments and other receivables 19,805 18,787 19,495 20,155 22,454 Net interest paid -2,270 -1,412 -841 -956 -945

Prepaid lease payments 335 348 359 370 380 Others 2,664 1,093 0 0 0

Available-for-sale investment 4,400 3,259 1,349 1,349 1,349 Operating Cash Flow 26,367 13,046 15,812 18,476 20,479

Cash and cash equivalent 43,837 34,755 55,672 80,537 91,832 Acquisitions -8,970 -7,188 -1,275 0 0

Other current assets 42 1,243 1,318 1,318 1,318 Capex -9,866 -9,207 -9,234 -9,234 -9,234

Tax recoverable 151 92 92 92 92 Asset Sales 345 351 0 0 0

Pledged bank deposits 5,059 4,614 4,614 4,614 4,614 Investment 3,120 5,413 1,910 0 0

Current assets 200,562 205,526 247,723 280,689 313,882 Others -4,414 5,239 0 0 0

Investing Cashflow -19,785 -5,392 -8,599 -9,234 -9,234

PPE 58,743 62,180 63,900 65,481 66,935 Dividend (ordinary) -3,306 -3,220 -4,093 -4,185 -4,267

Investment properties 64 939 1,602 2,261 2,914 Equity Raised 7,822 0 0 12,000 0

Prepaid lease payments 13,548 14,428 14,880 15,319 15,744 Debt Movements 5,107 -11,294 17,797 7,873 4,316

Goodwill 792 1,315 1,315 1,315 1,315 Others -281 -237 0 -66 0

Other intangible assets 1,949 3,260 2,695 2,321 2,073 Financing Cashflow 9,343 -14,752 13,704 15,623 50

Long-term equity investment 4,814 3,613 4,273 4,999 5,797

Available-for-sale investment 1,022 3,157 3,157 3,157 3,157 Exchange difference -83 8 0 0 0

Deferred tax assets 1,928 2,744 2,744 2,744 2,744 Net Chg in Cash/debt 15,842 -7,090 20,917 24,865 11,294

Other non-current assets 15,393 14,533 14,533 14,533 14,533 FCF 6,583 7,654 7,214 9,242 11,245

Non-current assets 98,252 106,168 109,099 112,129 115,212 2014 2015 2016E 2017E 2018E

Valuation

Total assets 298,814 311,694 356,821 392,818 429,094 PE(x) 16.1 15.2 14.9 15.4 13.7

EPS growth(%) 36.3 5.9 2.2 -3.1 12.3

Trade payables 71,390 83,179 100,579 103,985 115,848 Yield(%) 0.0 2.3 2.3 2.3 2.5

Bills payables 21,551 22,790 18,528 19,155 21,340 PEG(%) 0.4 2.6 6.7 -5.0 1.1

Other payables and accruals 47,539 41,245 44,996 46,519 51,827 EV/EBITDA(x) 4.2 7.4 6.7 6.3 5.5

Short-term debt 27,375 15,260 32,543 38,448 28,836 PB(x) 1.0 1.9 1.7 1.5 1.4

Retirement benefit obligagtions 391 352 352 352 352

Tax payables 1,310 1,534 1,534 1,534 1,534 Operational

Provision fro warranties 1,952 2,280 2,323 2,394 2,665 Revenue growth(%) 126.3 8.9 1.9 3.0 11.3

Other current liabilities 1,404 2,451 2,451 2,451 2,451 EBIT margin(%) 161.0 12.0 4.2 2.0 12.0

Current liabilities 172,913 169,091 203,306 214,838 224,854 Net profit margin(%) 161.2 9.3 2.2 1.8 12.6

Long-term debt 12,216 14,316 10,848 12,816 26,744 Days receivables 104 145 163 171 165

Long-term payables 239 276 276 276 276 Days payables 162 235 252 263 252

Retirement benefit obligations 4,201 4,054 4,054 4,054 4,054 Days inventories 92 114 121 130 127

Provision for warranties 1,795 3,741 3,741 3,741 3,741

Deferred tax liabilities 193 242 242 242 242 Current ratio((x) 1.2 1.2 1.2 1.3 1.4

Other non-current liabilities 5,079 6,398 10,380 10,380 10,380 Quick ratio(x) 0.8 0.9 0.9 1.0 1.0

Non-current liabilities 23,724 29,028 29,542 31,510 45,438 Asset/equity(x) 3.3 3.2 3.4 3.1 3.2

Net debt/equity(%) -4.8 -5.3 -11.7 -23.4 -27.0

Total liabilities 196,636 198,119 232,847 246,348 270,292 EBITDA interest coverage(x) 9.2 16.8 16.9 13.2 12.7

ROE(%) 12.1 12.2 11.5 9.8 10.3

Shareholders Fund 89,295 96,900 104,889 124,933 134,505

Minority Interest 12,882 16,674 19,084 21,537 24,297

Total S/H Equity 102,177 113,575 123,974 146,470 158,802

Total Liab & S/H Fund 298,814 311,694 356,821 392,818 429,094

4

Earnings outlook

Earnings growth to remain subdued in 2016 and 2017

We initiate coverage of CRRC with a Hold rating and target price of HK$7.72. With falling locomotive and MU sales, we expect its earnings growth to be dampened in 2016-2017. We forecast net profit growth of only 1-2% per annum in 2016-2017. We expect new rail line addition, an increase in HSR operation density, and rising MU maintenance demand to drive earnings growth only in 2018. Overall, we expect its net profit to grow 12.6% YoY in 2018. Our earnings estimates for the Company in 2016-2018 are in line with consensus.

Figure 1: Earnings estimates: CGIS vs. consensus estimates


Share price re-rating constrained by slow business recovery

We set a TP of HK$7.72 and have a Hold rating on CRRC. Our target price is based on a target multiple of 16x 2017E PER and suggests 3.5% upside potential. Histori-cally, the stock has traded at an average 18.6x PER. Currently it is trading at 15.4x 2017E PER.

We believe its share price re-rating will be constrained by slow locomotive and MU business growth recovery. We expect new line additions to drive only modest earn-ings growth for CRRC in the medium term. Considering maintenance revenue ac-counts for ~10% of total revenue, we think growth recovery from rising railway oper-ations and maintenance spending will drive its earnings growth less than market expectations. We expect its earnings to remain flattish in 2016-2017 and earnings growth to recover in 2018.

CRRC H-shares fell 23.3% in 2016 on weak earnings growth outlook, significantly underperforming the HSI Index. Since Jan 2017, CRRC’s share prices have been boosted by market expectations of railway equipment demand recovery and over-seas business expansion. CRRC’s H-share price has risen 6.9% YTD, while HSI Index rose 9.0% YTD. CRRC H-shares are trading at more than a 36% discount to its A-shares vs. a historical average A-H share discount of 34%. We don’t expect further south-bound fund flow to drive the share price, as investors remain con-cerned about its lackluster earning growth outlook.


CGIS 242,311 18,207 25,159 12,082 0.44 0.44

Consensus 236,642 17,210 23,525 11,705 0.43 0.43

Diff% 2.4% 5.8% 6.9% 3.2% 3.2% 2.3%


CGIS 249,659 18,571 25,490 12,294 0.43 0.43

Consensus 252,058 18,889 25,371 12,880 0.46 0.48

Diff% -1.0% -1.7% 0.5% -4.5% -7.5% -11.3%


CGIS 277,982 20,793 27,732 13,839 0.48 0.48

Consensus 272,951 20,761 27,480 14,400 0.51 0.54

Diff% 1.8% 0.2% 0.9% -3.9% -6.0% -11.2%

5


Figure 2: CRRC H-share 12-mth forward PER


Figure 3: CRRC H-share 2016 performance


Figure 4: CRRC H-share CYTD performance


Figure 5: CRRC A/H premium (discount) band

-30.0%

-25.0%

-20.0%

-15.0%

-10.0%

-5.0%

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10.0%

15.0%

CRRC HSI Index

-2.0%

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CRRC HSI Index

-80.0%

-60.0%

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60.0%

80.0%

Aug-08 Aug-09 Aug-10 Aug-11 Aug-12 Aug-13 Aug-14 Aug-15 Aug-16

A/H premium (discount) Average +1 Stedev -1 Stdev

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6

Slow railway equipment business recovery in 2017

We expect CRRC’s railway equipment business revenue growth recovery to be slow in 2017. With falling locomotive and MU business revenue, we expect its earnings growth to be dampened in 2016-2017. We forecast that its revenue will remain largely flat YoY in 2016-2017. We expect new line addition, increasing HSR train density and rising maintenance demand to drive business growth recovery only from 2018. We expect its revenue to grow 11.3% YoY in 2018.

We forecast a 30.0% YoY decline in CRRC’s locomotive business revenue in 2016. Revenue growth in its MU and urban transit vehicle business should offset a revenue decline in its locomotive business revenue in 2016. We expect locomotive revenue growth to recover in 2017. CRC made tenders for 585 locomotives in Jan 2017, ~3x the total tender volume in 2016. We forecast that its locomotive business revenue will grow 40% YoY in 2017. We expect its railway freight business expansion to drive loco-motive demand growth in 2018 and its locomotive revenue to grow 10% YoY in 2018.

We forecast that its MU business revenue will grow 12.0% YoY in 2016. But we expect MU tenders from CRC to decline in 2017, considering new line addition in 2017 will come in below that in 2016. We forecast that its MU business revenue will fall 25% YoY in 2017. We expect new line addition and increasing HSR operation density to drive only modest MU demand growth. We expect rising maintenance demand to drive its MU business revenue growth, though later than market expectations. We forecast that its MU business revenue will grow 11.6% YoY in 2018.


Source: CGIS Research estimates

Figure 6: CRRC Times Electric 2017E revenue breakdown


Figure 7: CRRC railway equipment business revenue progression

Locomotives, 13%

Passenger carriages, 5%

Freight wagons, 4%

Multiple units, 27%

Rapid transit vehicles and

urban infrastructure,

13%

New businesses, 28%

Modern service, 11%

-6.0%

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100,000

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2014 2015 2016E 2017E 2018E


7

Urban transit vehicle business and new business

expansion to continue in 2017

In 2016-2018, we expect CRRC’s urban transit vehicle business revenue growth to remain on the fast track, with urban transit business revenue growing by 20% per an-num. As at the end of 9M16, the order backlog for its urban transit vehicle business stood at RMB106.9bn, equivalent to 4.4x of its urban transit business revenue in 2015.

CRRC has diversified into other new business areas for sustainable long-term busi-ness growth, expanding its business into the new energy and environmental protection equipment industries. It has also invested heavily in IGBT business development. It even the entered deep-sea marine equipment industry after its subsidiary acquired a UK company which specializes in the field. We forecast that its new business revenue will grow by 10-15% per annum in 2016-2018.

CRRC is also involved in modern logistics services and financial leasing. The revenue from these two segments falls under the ‘other’ business segment. We expect revenue growth of its ‘other’ business to be driven mainly by its financial leasing business ex-pansion. Overall, we expect its ‘other’ business revenue to grow 10% per annum in 2017-2018. The revenue decline in 2016 was led mainly by its logistics service busi-ness, which should fit senior management’s intention to lower the revenue contribution from its lower-margin logistics business.



Figure 8: CRRC urban transit vehicle business revenue progression


Figure 9: CRCC new business and other business revenue progression

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2014 2015 2016E 2017E 2018E

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8

Overseas business growth is no rescue for its

core business slow-down in the short term

The OBOR (One Belt, One Road) initiative and China’s high-speed railway strategy will provide overseas growth opportunities for domestic railway construction and equip-ment companies. The initiative shows China’s intention to expand trade and capital links with APEC countries and other OECD countries and to resolve excess production capacity to stimulate economic growth in China and neighbouring countries. We think the central government’s support should help domestic companies expand their over-seas business, but at a slower pace than expected and more likely in the long term.

Fewer-than-expected overseas railway project contract wins in recent years indicate that railway contract wins in overseas market is more difficult than we previously thought. The competition in overseas markets is intense. Chinese companies face competition from their peers from Japan and Europe, which offer strong technology and products. In addition, foreign companies have already built strong local economic ties in some OBOR countries. They also promise to provide funding for overseas rail-way projects. In some cases, there are geopolitical reasons for Chinese companies’ losing project bids to their overseas competitors. For instance, the consortium formed by Chinese railway construction and equipment companies lost some project bids to their Japanese competitors in India, Thailand etc.



Figure 10: Overseas railway project list

9

Cost synergy to gradually kick in to maintain sta-

ble margins

We believe CRRC can gradually benefit from cost synergy with the integration of the purchasing systems from the previous CSR and CNR, expanding its gross profit mar-gin from 19.6% in 2015 to 20.3% in 2016. Even with changes in product mix and the increasing revenue contribution from its lower margin urban transit and ‘other’ busi-ness, we expect its gross profit margin to largely stabilize at around 20% in 2017-2018.

We also expect cost savings in SG&A, driven by its business restructuring. We expect its operating profit margin to stabilize at 7.6% in 2016-2018 after factoring in other one-off gains and losses. With rising financing costs, we expect its net profit margin to re-main stable at 5.9-6.0% in 2016-2018.


Figure 11: CRRC profit margin progression

19.2%

19.4%

19.6%

19.8%

20.0%

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20.4%

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12.0%

2014 2015 2016E 2017E 2018ENet profit margin Operating profit margin

Gross profit margin(rhs)

10

Appendix

Company profile

In 2015, with the consent of the State Council and the approval of the SASAC, CRRC was formed from a merger of China CNR Corporation and CSR Corporation. In the same year, the Company was listed on the Shanghai Stock Exchange and Hong Kong Stock Exchange with the approval of CSRC. In 2015, after the merger, CRRC became the world’s largest supplier of rail transportation equipment in terms of total sales. It is involved in the production and sales of locomotives, MUs, freight wagons, passenger carriages and urban transit vehicles. It has also expanded its business into other sec-tors, such as new energy equipment, engineering machinery, IGBT and deep-sea ma-rine engineering equipment. The Chinese market is its main revenue source, repre-senting 89% of total revenue in 2015.

Major shareholders


Management profile

Mr. Cui Dianguo: Mr. Cui, aged 63, is chairman of the Board of the Company. Mr. Cui has a Master’s degree and is a professor-level senior engineer. He was general man-ager and deputy party secretary of the CNR in 2008-2015. He became deputy party secretary and chairman of the Board of CRRC in 2015.

Mr. Xi Guohua: Mr. Xi, aged 54, is general manger of CRRC. He previously served as deputy director, director and deputy party secretary of Zhuzhou Electric Locomotive Research Institute. In 2010-2015, he was executive director, president and deputy par-ty secretary. He became general manager of CRRC in May 2015. Mr. Xi was granted the Zhan Tianyou Award for railway science and technology achievement and was an expert on the professional team of modern transportation technology in the state “863” program.

Mr. Xie Jilong: Mr. Xie, aged 51, is secretary of the Board of the Company. He is a professor-level senior economist. He served as chief accountant, deputy head, head and deputy party secretary in a few subsidiaries of CNR. He served as secretary of the Board of CNR in 2008-2015. He became secretary of the Board of CRRC in 2015.

CRCCG, 54.2%

China Securities Finance

Corporation, 2.8%

CRRC Financial and Securities,

1.39%

Central Huijin, 1.12%

Other investors, 40.49%

1

CRRC Times Electric [3898.HK]

Hold

Close: HK$43.95 (Feb 20, 2017)


Price Performance


Shares Outstanding 547m

Auditor Ernst & Young

Free Float 100.0%

52W range HK$36.50-49.50


Major Shareholding CRRC ZELRI (50.2%)


Kelly Zou—Analyst

(852) 3698-6319

[email protected]


(852) 3698-6317

[email protected]


China Railway Sector We initiate coverage on CRRC Times Electric with a Hold rating and a TP of HK$47.60. We expect its earnings growth to recover in 2017. We forecast that net profit will grow at a CAGR of 12.1% in 2016-2018. We expect likely falling MU prod-uct business revenue to constrain its earnings growth in 2017. But we believe its urban transit product sales and other new business sales growth will remain firm, partially offsetting the growth slowdown in its railway business. We expect cost sav-ings from its acquisition of the IGBT production line only to help it maintain stable margins. We think its earnings growth recovery in 2017 has largely been factored into the share price. A further share price catalyst would be CRC’s incoming MU tenders to bring more clarity to its earnings growth outlook in 2017 and 2018.


Late-cycle spending on railway operations to drive its railway business

growth recovery: We expect a gradual recovery in demand for the locomotive and MU product segment resulting from the 13th FYP. New HSR line additions are expected to drive only modest demand growth for MUs. But increases in HSR speed and the CRC focus on shifting railway operations should drive oper-ation and maintenance demand for its products. The expansion of the railway freight business also supports demand growth for its locomotive products. We expect urban transit product revenue growth to remain firm in 2016-2018. Over-all, we expect its core train-borne electrical systems (>70% of its total revenue) to grow at a CAGR of 10.5% in 2016-2018.

IGBT and deep-sea marine engineering product business to drive long-

term growth: We forecast that the Company’s electric parts and components business revenue will grow at a CAGR of 15.0% in 2016-2018. It has applied its IGBT modules to its urban transit vehicle products. As its urban transit vehicle equipment sales growth should remain strong in 2016-2018, we expect this to drive IGBT production to achieve economies of scale and generate profit. We expect its marine engineering product segment revenue to grow at a CAGR of 7.5% in 2016-2018. The Company plans to build a plant for this business in Mainland China. Given the lack of major domestic competitors in the deep-sea marine equipment sector and SMD’s (Soil Machine Dynamics Ltd) leading mar-ket share, it should be able to gradually develop its sales in the domestic market in the long term.

HOLD with a TP of HK$47.60: Our TP is based on a target multiple of 15.0x

2017E PER, which suggests 8.3% upside potential. The stock has historically traded at an average PER of 18.7x. With slower EPS growth, we believe a lower PER multiple is appropriate. A further share price catalyst would be CRC’s in-coming MU tenders to bring more clarity to its earnings growth outlook in 2017 and 2018.

INITIATE COVERAGE: Growth to recover in 2017 but reflected in share price

February 21, 2017

Y/E Dec 31 2013 2014 2015 2016E 2017E 2018E

Turnover (RMB m) 8,856 12,676 14,145 15,380 16,603 18,775


Net margin (%) 16.6% 18.9% 20.9% 19.4% 19.9% 19.9%


% change 18.1% 52.9% 23.5% 0.7% 10.9% 13.3%

PER(x) 29.2 19.1 15.5 15.4 13.9 12.2

PBR(x) 5.1 4.2 3.4 2.9 2.5 2.1

EV/EBITDA(x) 23.4 14.7 11.9 10.6 9.2 7.8

0

200

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2

Key financials


Revenue breakdown (Rmb m) 2011 2012 2013 2014 2015 2016E 2017E 2018E

Locomotive 2,214 1,584 2,906 3,704 3,559 2,847 3,702 4,072

MU 2,538 2,229 2,315 4,759 4,951 5,942 5,050 5,555

Urban rail equipment 495 928 956 1,208 1,873 2,622 3,409 4,091

Train power converters and control systems 5,247 4,741 6,177 9,671 10,384 11,411 12,161 13,718

Train operation safety equipment 440 613 571 575 561 510 561 645

ECS for large railway maintenance vehicles 597 976 1,103 1,149 1,495 1,764 2,029 2,333

Train-borne electrical systems 6,284 6,330 7,851 11,394 12,440 13,686 14,751 16,697

Key electric part and component products 841 919 1,005 631 646 729 839 965

Marine engineerging products and others 0 0 0 651 1,060 964 1,013 1,114

Total revenue 7,125 7,249 8,856 12,676 14,145 15,380 16,603 18,775

% YoY

Locomotive -5.8% -28.5% 83.5% 27.5% -3.9% -20.0% 30.0% 10.0%

MU 72.5% -12.2% 3.9% 105.6% 4.0% 20.0% -15.0% 10.0%

Urban rail equipment 58.4% 87.5% 3.0% 26.4% 55.1% 40.0% 30.0% 20.0%

Train power converters and control systems 26.9% -9.6% 30.3% 56.6% 7.4% 9.9% 6.6% 12.8%

Train operation safety equipment 7.1% 39.4% -6.9% 0.6% -2.4% -9.0% 10.0% 15.0%

ECS for large railway maintenance vehicles 5.4% 63.5% 13.0% 4.1% 30.2% 18.0% 15.0% 15.0%

Train-borne electrical systems 22.9% 0.7% 24.0% 45.1% 9.2% 10.0% 7.8% 13.2%

Key electric part and component products 8.5% 9.3% 9.4% -37.3% 2.3% 13.0% 15.0% 15.0%

Marine engineerging products and others na na na na 62.7% -9.0% 5.0% 10.0%

Total revenue 21.0% 1.7% 22.2% 43.1% 11.6% 8.7% 8.0% 13.1%

% of total

Locomotive 31% 22% 33% 29% 25% 19% 22% 22%

MU 36% 31% 26% 38% 35% 39% 30% 30%

Urban rail equipment 7% 13% 11% 10% 13% 17% 21% 22%

Train power converters and control systems 74% 65% 70% 76% 73% 74% 73% 73%

Train operation safety equipment 6% 8% 6% 5% 4% 3% 3% 3%

ECS for large railway maintenance vehicles 8% 13% 12% 9% 11% 11% 12% 12%

Train-borne electrical systems 88% 87% 89% 90% 88% 89% 89% 89%

Key electric part and component products 12% 13% 11% 5% 5% 5% 5% 5%

Marine engineerging products and others 0% 0% 0% 5% 7% 6% 6% 6%

Total revenue 100% 100% 100% 100% 100% 100% 100% 100%

CRRC Times Electric (3898 HK)



FY ended 31 Dec 1H14 2H14 1H15 2H15 1H16 2H16E P&L 2013 2014 2015 2016E 2017E 2018E

Sales Revenue 5,180 7,496 5,723 8,422 6,533 8,847 Sales Revenue 8,856 12,676 14,145 15,380 16,603 18,775

COGS -3,324 -4,553 -3,460 -5,147 -4,054 -5,372 COGS -5,695 -7,876 -8,608 -9,426 -10,212 -11,571

Gross profit 1,857 2,943 2,263 3,274 2,479 3,474 Gross profit 3,161 4,800 5,537 5,954 6,391 7,205

Sales tax -30 -70 -37 -64 -39 -53 Sales tax -75 -100 -100 -92 -100 -113

Selling and distribution costs -275 -606 -243 -404 -263 -398 Selling and distribution costs -498 -881 -647 -661 -714 -807

Administrative expenses -494 -855 -679 -927 -803 -966 Administrative expenses -1,005 -1,349 -1,606 -1,769 -1,843 -2,084

Other gains and losses -48 238 48 134 146 -116 Other gains and losses 81 190 182 30 50 50

Total EBIT 1,010 1,650 1,351 2,014 1,519 1,942 Total EBIT 1,664 2,660 3,365 3,461 3,784 4,251

Depreciation & Amortisation 89 180 136 147 135 271 Depreciation & Amortisation 160 268 283 406 476 479

EBITDA 1,099 1,830 1,487 2,161 1,654 2,213 EBITDA 1,824 2,929 3,648 3,867 4,260 4,729

Net finance costs 10 33 45 -20 -53 -12 Net finance costs 27 43 25 -65 -14 26

Profits from associates and JCEs 32 20 35 20 35 35 Profits from associates and JCEs 13 52 55 70 70 70

Pre-Tax Profit 1,052 1,703 1,431 2,014 1,501 1,965 Pre-Tax Profit 1,704 2,755 3,445 3,466 3,840 4,347

Tax Expense -197 -166 -212 -264 -207 -261 Tax Expense -237 -363 -476 -468 -518 -587

Net Profit After Tax 855 1,537 1,220 1,750 1,294 1,704 Net Profit After Tax 1,466 2,392 2,970 2,998 3,322 3,760

Minority Interest 3 0 0 -11 -8 -12 Minority Interest 1 3 -11 -20 -20 -20

Reported Earnings (attributable) 857 1,537 1,220 1,739 1,286 1,692 Reported Earnings 1,467 2,395 2,958 2,978 3,302 3,740

Adjusted Earnings 857 1,537 1,220 1,739 1,286 1,692 Adjusted Earnings 1,467 2,395 2,958 2,978 3,302 3,740

EPS (rep) 0.73 1.31 1.04 1.48 1.09 1.44 EPS (rep) 1.33 2.04 2.52 2.53 2.81 3.18

EPS (adj) 0.73 1.31 1.04 1.48 1.09 1.44 EPS (adj) 1.33 2.04 2.52 2.53 2.81 3.18

DPS 0.00 0.40 0.00 0.45 0.00 0.45 DPS 0.35 0.40 0.45 0.45 0.50 0.57

% YoY growth % YoY growth 47.60 12.0%

Revenue 97.4% 20.3% 10.5% 12.4% 14.2% 5.0% Revenue 22.2% 43.1% 11.6% 8.7% 8.0% 13.1%

Gross profit 86.3% 36.0% 21.9% 11.3% 9.6% 6.1% Gross profit 29.2% 51.8% 15.4% 7.5% 7.3% 12.7%

EBIT 117.5% 37.6% 33.8% 22.0% 12.5% -3.6% EBIT 26.3% 59.9% 26.5% 2.9% 9.3% 12.3%

Net profit 114.3% 44.1% 42.3% 13.1% 5.5% -2.7% Net profit 19.9% 63.2% 23.5% 0.7% 10.9% 13.3%


Gross profit margin 35.8% 39.3% 39.5% 38.9% 37.9% 39.3% Gross profit margin 35.7% 37.9% 39.1% 38.7% 38.5% 38.4%

EBITDA Margin 21.2% 24.4% 26.0% 25.7% 25.3% 25.0% EBITDA Margin 20.6% 23.1% 25.8% 25.1% 25.7% 25.2%

EBIT Margin 19.5% 22.0% 23.6% 23.9% 23.3% 21.9% EBIT Margin 18.8% 21.0% 23.8% 22.5% 22.8% 22.6%

Net Profit Margin 16.6% 20.5% 21.3% 20.6% 19.7% 19.1% Net Profit Margin 16.6% 18.9% 20.9% 19.4% 19.9% 19.9%

3

Key financials


CRRC Times Electric (3898 HK)



Balance sheet 2013 2014 2015 2016E 2017E 2018E Cash flow statement 2013 2014 2015 2016E 2017E 2018E

Cash 3,136 2,680 3,404 5,894 7,840 9,858 EBITDA 1,824 2,929 3,648 3,867 4,260 4,729

Trade and bill receivables 4,907 5,998 7,912 8,924 9,734 11,008 Net Interest Paid 27 43 25 -65 -14 26

Inventories 1,428 2,207 3,069 3,228 3,497 3,963 Tax Paid -237 -363 -476 -468 -518 -587

Prepayments 156 227 348 379 409 463 Change in Working Cap -900 1,026 -1,595 -922 -692 -981

Other current assets 1,185 3,054 3,270 1,156 1,156 1,156 Others 12 -1,578 22 0 0 0

Total current assets 10,813 14,166 18,003 19,580 22,636 26,447 Operating Cash Flow 726 2,057 1,624 2,411 3,036 3,188

Long-term equity investment 233 237 222 292 362 432 Acquisitions -1,101 -4,500 -6,364 0 0 0

PPE, net 1,830 1,883 1,972 3,080 3,114 3,143 Capex -298 -338 -281 -1,502 -500 -500

Other intangible assets 294 284 690 678 668 660 Asset Sales 5 3 8 0 0 0

Goodwill 14 14 575 575 575 575 Others 67 2,707 5,155 2,114 0 0

Prepaid land lease payments 0 0 0 0 0 0 Investing Cashflow -1,327 -2,128 -1,481 612 -500 -500

Deferred tax assets 129 251 280 280 280 280

Other non-current assets 86 90 71 71 71 71 Dividend (ordinary) -382 -412 -487 -532 -590 -669

Total non-current assets 2,586 2,759 3,809 4,976 5,070 5,161 Equity Raised 1,776 0 0 0 0 0

Debt Movements 29 -38 1,031 0 0 0

Total assets 13,398 16,925 21,812 24,556 27,705 31,608 Others 0 52 15 0 0 0

Financing Cashflow 1,422 -398 559 -532 -590 -669

Trade and bill payable 2,679 3,431 4,166 4,132 4,421 5,009

Short term Debt 43 16 70 70 70 70 Exchange difference 0 -1 1 0 0 0

Other payables and accruals 678 1,014 1,237 1,549 1,679 1,902 Net Chg in Cash/debt 821 -471 703 2,490 1,945 2,019

Provision 130 330 368 368 368 368 FCF -601 -72 143 3,023 2,536 2,688

Tax payable 199 147 250 250 250 250

Other current liabilities 92 50 59 59 59 59 2013 2014 2015 2016E 2017E 2018E

Total current liabilities 3,821 4,987 6,150 6,429 6,847 7,658 Valuation

PE(x) 29.2 19.1 15.5 15.4 13.9 12.2

Long Term Debt 52 37 1,025 1,025 1,025 1,025 EPS growth (%) 18.1 52.9 23.5 0.7 10.9 13.3

Deferred tax liabilities 15 14 100 100 100 100 Yield(%) 0.9 1.0 1.2 1.2 1.3 1.5

Provision 209 480 515 515 515 515 PEG(%) 1.6 0.4 0.7 23.2 1.3 0.9

Long-term payables 151 169 229 229 229 229 EV/EBITDA(x) 23.4 14.7 11.9 10.6 9.2 7.8

Other non-current liabilities 0 66 116 116 116 116 PB(x) 5.1 4.2 3.4 2.9 2.5 2.1

Total non-current liabilities 428 767 1,986 1,986 1,986 1,986

Operational

Total liabilities 4,248 5,754 8,136 8,414 8,832 9,643 Revenue growth(%) 22.2 43.1 11.6 8.7 8.0 13.1

EBIT margin(%) 18.8 21.0 23.8 22.5 22.8 22.6

Shareholders Fund 9,016 10,991 13,472 15,918 18,629 21,700 Net profit margin(%) 16.6 18.9 20.9 19.4 19.9 19.9

Minority Interest 134 180 204 224 244 264

Total S/H Equity 9,150 11,171 13,677 16,142 18,873 21,964 Days receivables 182 163 187 208 214 210

Days payables 187 181 209 215 211 205

Total Liab & S/H Fund 13,398 16,925 21,812 24,556 27,705 31,608 Days inventories 81 84 112 122 120 118

BVPS 7.67 9.35 11.46 13.54 15.85 18.46 Current ratio((x) 2.8 2.8 2.9 3.0 3.3 3.5

EV 42,701 43,115 43,433 40,943 38,997 36,979 Quick ratio(x) 2.5 2.4 2.4 2.5 2.8 2.9

Asset/equity(x) 1.5 1.5 1.6 1.5 1.5 1.5

Net debt/equity(%) -33.7 -23.9 -17.1 -30.1 -36.2 -40.4

EBITDA interest coverage(x) -267.0 369.3 96.7 28.2 30.9 34.1

ROE(%) 16.3 21.8 22.0 18.7 17.7 17.2

4

Earnings outlook

Earnings growth to recover in 2017

We initiate coverage on CRRC Times Electric with a Hold rating and a TP of HK$47.60. We expect its earnings growth to recover in 2017. We forecast that net profit will grow at a CAGR of 12.1% in 2016-2018. We expect likely falling MU prod-uct business revenue to constrain its earnings growth in 2017. But we believe its ur-ban transit product sales and other new business sales growth will remain firm, which partially offsetting the growth slowdown in its railway business. We expect cost sav-ings from its acquisition of the IGBT production line to only help it maintain stable margins. As the late-cycle beneficiary from railway investment, we expect the Com-pany to benefit from both new line addition and railway’s increasing investment for operation efficiency and safety. But earnings visibility is still low, pending on incoming MU tenders. Our earnings forecast is largely in line with consensus s earnings esti-mates.



Share price upside relies on CRC’s MU tenders in 2017

We give a Hold rating to CRRC Times Electric with a target price of HK$47.60, which is based on a target multiple of 15.0x 2017E PER. Our target price suggests 8.3% upside potential. The stock has historically traded at an average PER of 18.7x. Currently the stock trades at 13.9x 2017E PER. We use a lower PER multi-ple as the EPS growth in the next few years is slower compared with the past few years.

We expect demand growth for its locomotive and MU products to slow down from new line additions, increased railway maintenance and operation spending should drive demand growth for its core train-borne electrical systems business. We think its earnings growth recovery in 2017 has largely factored into the share price. Fur-ther share price catalyst would be CRC’s incoming MU tenders, which should bring more clarity on its earnings growth outlook in 2017 and 2018.


CGIS 15,380 3,461 3,867 2,978 2.53 2.53

Consensus 14,613 3,182 3,519 2,909 2.48 2.50

Diff% 5.2% 8.8% 9.9% 2.4% 2.0% 1.5%


CGIS 16,603 3,784 4,260 3,302 2.81 2.81

Consensus 16,141 3,546 3,926 3,240 2.75 2.84

Diff% 2.9% 6.7% 8.5% 1.9% 2.0% -1.2%


CGIS 18,775 4,251 4,729 3,740 3.18 3.18

Consensus 17,952 3,914 4,326 3,650 3.10 3.21

Diff% 4.6% 8.6% 9.3% 2.5% 2.6% -0.8%

5


Figure 2: CRRC Times Electric 12-mth forward PER

The Company’s share price underperformed the HSI Index in 2016 due to a weak demand growth outlook for its core locomotive and MU product business. Led by CRC’s recovering tenders on locomotives and freight wagons, its share price has risen 11.6% YTD, in line with the HSI Index. CRRC Times Electric is also a selected stock under Shenzhen-Hong Kong Stock Connect. Considering its attractive valuation compared with its A-share-listed peers, we expect fund flows from the north to support the share price rebound.


Figure 3: CRRC Times Electric 2016 share price performance


Figure 4: CRRC Times Electric CYTD share price performance

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6

Spending on late-cycle railway operations to off-

set its core railway business slow-down

We expect only modest demand recovery in the Company’s locomotive and MU prod-

uct segment, based on the 13th FYP,. We expect the growth to be driven mainly by

increased spending on late-cycle railway maintenance and operations. Overall, we

expect its core train-borne electrical systems business (>70% of its total revenue) to

grow at a CAGR of 10.5% in 2016-2018.

Facing weak freight volume, CRC procured fewer locomotives in 2015-2016 to lift

freight transportation capacity. We expect the Company’s locomotive product business

revenue to fall 20% YoY in 2016. We expect locomotive demand growth to recover in

2017-2018, considering CRC is to grow its freight business into non-bulk logistics

transportation market. Going forward, we expect CRC’s railway business expansion to

drive demand growth for the Company’s locomotive products. CRC made its first 2017

tender in Jan for 586 locomotives, while it procured only 202 locomotives in 2016. We

expect additional locomotive tenders to follow in the coming months. Overall, we fore-

cast the Company’s locomotive product business revenue to grow 30% YoY in 2017

and 10% YoY in 2018.

We expect its MU product business to deliver 20% YoY revenue growth in 2016, driv-

en by new line addition. But we expect MU product sales to decline 15% YoY in 2017,

considering total mileage of new line addition in 2017 will be less than that in 2016.

CRC released tenders for 131 MUs in Dec 2016 and 50 MUs in Jan 2017. We expect

additional MU tenders in 2017, but we expect MU product delivery in 2017 to come

below the level in 2016. We expect the Company’s MU product sales to grow 10%

YoY in 2018, driven by new line addition, increasing HSR operation density and rising

MU maintenance demand. We expect new line addition for national and intercity rail-

ways to only drive modest MU product demand growth, and rising maintenance spend-

ing and HSR operation density to boost MU product sales growth.



Figure 5: Locomotive product business sales progression


Figure 6: MU product business sales progression

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7

We expect its urban transit vehicle equipment business growth to remain firm in 2016-

2018. Overall, we forecast that its urban rail equipment sales revenue will grow at a

CAGR of 24.9% YoY in 2016-2018, led mainly by new line addition in the period.

Rising railway operation spending on safety equipment and railway maintenance ma-

chinery will also boost revenue growth in these two segments. We expect the Compa-

ny’s train operation safety system business revenue to grow at a CAGR of 9.6% in

2016-2018. We forecast that its ECS sales for large railway maintenance machine

vehicles will grow at a CAGR of 12.5% in 2016-2018.



Figure 7: Urban transit vehicle product revenue progression (Rmb m)


Figure 8: Operation safety equipment and ECS revenue progression (Rmb m)

0

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2007 2008 2009 2010 2011 2012 2013 2014 2015 2016E2017E2018E

Train operation safety equipment

ECS for large railway maintenance vehicles

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8

We also forecast that its electrical parts and components business revenue will grow at a CAGR of 15.0% in 2016-2018. The Company has successfully applied its IGBT mod-ules in its urban transit vehicle products. As its urban transit vehicle equipment sales growth is expected to remain strong in 2016-2018, we expect this to drive its IGBT pro-duction to achieve economies of scale and generate profit. The Company also sells its IGBT products to grid and new energy equipment manufacturers. We expect invest-ment growth in grid networks and new energy equipment to remain strong in 2017-2018 as the central government takes steps to improve energy efficiency and reduce air pollution.

We expect its marine engineering product segment revenue to grow at a CAGR of

7.5% in 2016-2018. The Company aims to build a plant for this business in Mainland

China. There are no major domestic competitors in the deep-sea marine equipment

field. SMD, which it acquired in early 2015, is a leading player in the global marine

equipment market. We believe the Company should be able to gradually develop its

sales in the Mainland market.



Figure 9: Electric component segment revenue progression


Figure 10: Marine engineering product segment revenue progression

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New business growth to continue in 2017-2018

9

No further margin expansion in 2017-2018

We project stable gross profit margins for its individual product segments in 2016-2018. We expect its gross profit margin to contract from 39.1% in 2015 to 38.4-38.7% in 2016-2018, respectively, due to changes in product mix. We expect its urban transit vehicle equipment to deliver faster growth than its locomotive and MU product seg-ment, but the former has lower margins than the latter.

We expect the Company to see modest operating margin expansion in 2017-2018. It completed the acquisition of the IGBT production line from CRRC in Dec 2016 and will be able to cut its rental expenses for the production line from 2017 onwards. We esti-mate additional depreciation expense will be roughly 50% of the previous rental ex-pense per annum, equivalent to 0.5% of its total sales. We forecast that its SG&A costs as a percentage of sales will fall at least from 15.9% in 2015 to 15.4-15.8% in 2016-2018. We forecast a contraction in operating profit margin from 23.8% in 2015 to 22.5% in 2016. We only expect operating profit margin to recover to 22.6-22.8% in 2017-2018. Overall, we expect its net profit margin to stabilize at 19-20% in 2016-2018.


Figure 11: CRRC Times Electric margins

2011 2012 2013 2014 2015 2016E 2017E 2018E

Gross profit margin 35.5% 33.7% 35.7% 37.9% 39.1% 38.7% 38.5% 38.4%

EBITDA margin 21.0% 20.2% 20.6% 23.1% 25.8% 25.1% 25.7% 25.2%

Operating profit margin 19.1% 18.2% 18.8% 21.0% 23.8% 22.5% 22.8% 22.6%

Net profit margin 16.6% 16.9% 16.6% 18.9% 20.9% 19.4% 19.9% 19.9%

10

Appendix

Company profile

CRRC Times Electric is a second-tier subsidiary of CRRC. Its parent company is CRRC Zhuzhou Institute, which was established in 1959. Times Electric was listed on the Hong Kong Stock Exchange in 2006. The Company is involved mainly in providing train-borne electrical systems for locomotives, MUs and urban transit vehicles. It also supplies railway operation safety systems and ECS for large railway maintenance vehi-cles. It diversified into IGBT and deep-sea marine engineering products. In 2008, it acquired a 75% stake in Dynex Power in the UK for its IGBT business. In 2015, it ac-quired a 100% stake in SMD for its marine engineering business.

Major shareholders

Figure 23 CRRC Times Electric’s major shareholders


Management profile

Mr. Ding Rongjun: Mr. Ding, aged 55, is the chairman of the Board of the Company. He has served in senior management in a few ZELRI-related companies. He graduat-ed from Southwest Jiaotong University with a Bachelor’s degree in electric locomotives in 1984. He earned a Master’s degree in traffic information and control in 1998 from the Changsha Railway Institute and a Master’s degree in management science and engi-neering in 1999 from Central South University.

Mr. Liu Ke’an: Mr. Liu, aged 45, is the general manager of CRRC Times Electric. He is a director of Dynex and the chairman of the Board of Directors of Hunan CSR Wab-tec. Mr. Liu is a professorate senior engineer. He joined CRRC ZELRI in 1994. He graduated from the Department of Electrical Engineering of Tongji University in 1994 with a Bachelor’s degree in engineering, majoring in industrial electrical automation. He earned a Master’s degree in corporate management from Zhongnan University of Eco-nomics and Law in 2016.

Mr. Yan Wu: Mr. Yan, aged 49, is the secretary of the Board of the Company. He is an executive director of HK Electric, Times Australia, Times USA and Times Basil. He graduated from Northwestern Polytechnic University, where he received a Bachelor’s degree in electro-technology in 1989 and a Master’s degree in aircraft navigation and

CRRC ZELRI, 50.2%

Othe CRRC-related

shareholders, 3.4%

Other institutional

shareholders, 46.4%

11

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BUY share price will increase by >20% within 12 months in absolute terms :

SELL share price will decrease by >20% within 12 months in absolute terms :

HOLD no clear catalyst, and downgraded from BUY pending clearer signal to reinstate BUY or further downgrade to outright SELL :

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