Deutsche Bank Markets Research Asia China Transportation Road / Rail Industry China Rail Sector Date 29 January 2014 Recommendation Change Cutting earnings and TP on lower rail spending; prefer CSR, D/G CRG Mixed outlook ahead; still prefer rail equipment producers to constructors ________________________________________________________________________________________________________________Deutsche Bank AG/Hong Kong Deutsche Bank does and seeks to do business with companies covered in its research reports. Thus, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1. MICA(P) 054/04/2013. Phyllis Wang Research Analyst phyllis.wang@db.com Key Changes Company Target Price Rating0390.HK 5.19 to 3.77(HKD) Buy to Hold3898.HK 34.19 to 28.92(HKD) -1186.HK 9.34 to 7.02(HKD) -1800.HK 8.35 to 7.11(HKD) -1766.HK 8.92 to 7.53(HKD) -Source: Deutsche Bank Top picks CSR Corp Ltd (1766.HK),HKD5.73 BuyChina Comms Construct (1800.HK),HKD5.52 BuySource: Deutsche Bank Companies Featured CSR Corp Ltd (1766.HK),HKD5.73 Buy 2012A 2013E 2014EP/E (x) 15.814.310.9EV/EBITDA (x) 8.77.75.7Price/book (x) 2.31.61.5China Comms Construct (1800.HK),HKD5.52 Buy 2012A 2013E 2014EP/E (x) 7.55.14.6EV/EBITDA (x) 6.35.45.3Price/book (x) 1.10.70.7Zhuzhou CSR (3898.HK),HKD23.85 Buy 2012A 2013E 2014EP/E (x) 15.014.612.1EV/EBITDA (x) 10.38.56.7Price/book (x) 4.12.32.1China Railway Group (0390.HK),HKD3.53 Hold 2012A 2013E 2014EP/E (x) 7.76.25.8EV/EBITDA (x) 7.37.07.0Price/book (x) 1.00.70.6China Rail Construction (1186.HK),HKD6.49 Hold 2012A 2013E 2014EP/E (x) 7.75.95.6EV/EBITDA (x) 3.13.43.6Price/book (x) 1.20.80.7Source: Deutsche Bank Having turned negative on rail constructors post-2015 – as mentioned in our November 2013 FITT report – we now become more cautious on their 2014-2015 outlook due to lower investment. We believe the slowdown in growth in earnings and new orders may continue to dog CRCC’s and CRG’s stock prices, despite the share price correction over the past few months. We are downgrading CRG from Buy to Hold and maintaining CRCC at Hold due to a lack of earnings momentum and positive catalysts. We maintain our positive stance on the rail equipment sub-sector because of continued healthy earnings outlook. Our order of preference: CSR, CCC, Zhuzhou CSR, CRCC and CRG. Cutting rail investment, but positive rail equipment outlook in 2014-2015 intact Based on CRC’s 2014 budget and channel checks from an industry expert and corporate management at CSR and CRG, we cut our assumption for railway infrastructure spending during 2014-2015 by 11%. We believe the lower investment is due to CRC’s greater emphasis on project profitability and a shortage of funding. As a result, more new rail lines under plan in undeveloped areas will be negatively impacted. However, the impact on most high-speed rail lines under construction and new lines in developed areas should be limited, in our view. Economic recovery and railway reform may support better traffic growth. Hence, we cut our rail equipment spending assumption by only 3% for 2014-15 and expect it to register a CAGR of 15% over 2013-15. Reducing earnings estimates and target prices We cut 2014-15E earnings for CRCC/CRG by an average of 7%/9%, mainly due to lower sales (mostly from railway business). Meanwhile, we trim our 2014-2015 earnings forecasts by 1-2% for CSR and 1% for Zhuzhou CSR to reflect anticipated lower revenue. Accordingly, we reduce their target prices on the earnings downgrades and higher WACC (see page 2). Downgrading CRG to Hold; CSR is our top pick CRCC and CRG trade at PEs of 5.5x and 5.8x 2014E, below their three-year average of 7x. However, they do not look attractive given EPS CAGRs of only 4-5% in 2013-2015E (vs. 16% and 19% EPS CAGRs in 2011-2013). We downgrade CRG to Hold and maintain CRCC at Hold. Among the constructors, we most like CCC given its lowest railway exposure and cheapest valuation. We prefer equipment producers to constructors in 2014. CSR and Zhuzhou CSR’s 2014E PE valuations are 11x and 12x (vs. a three-year average of 15x), which we do not think is justified given their better earnings outlook. We forecast 24% and 17% CAGR in CSR’s and Z