China Rail Sector：Raising rail investment; reiterate positive view on rolling stock names

Deutsche Bank Markets Research Asia China Transportation Road / Rail Industry China Rail Sector Date 15 May 2014 Forecast Change Raising rail investment; reiterate positive view on rolling stock names Better S/T but mixed M/L outlook for constructors; Buy CSR/Zhuzhou CSR ________________________________________________________________________________________________________________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. MCI (P) 148/04/2014. Phyllis Wang Research Analyst phyllis.wang@db.com Key Changes Company Target Price Rating0390.HK 3.77 to 4.05(HKD) -3898.HK 28.92 to 30.54(HKD) -1186.HK 7.02 to 7.42(HKD) -1800.HK 7.11 to 6.85(HKD) -1766.HK 7.53 to 7.89(HKD) -Source: Deutsche Bank Top picks CSR Corp Ltd (1766.HK),HKD5.74 BuyZhuzhou CSR (3898.HK),HKD23.25 BuySource: Deutsche Bank Companies Featured CSR Corp Ltd (1766.HK),HKD5.74 Buy 2013A 2014E 2015EP/E (x) 15.511.09.5EV/EBITDA (x) 8.75.34.5Price/book (x) 1.91.61.4Zhuzhou CSR (3898.HK),HKD23.25 Buy 2013A 2014E 2015EP/E (x) 14.511.710.3EV/EBITDA (x) 9.36.95.8Price/book (x) 2.72.11.8China Comms Construct (1800.HK),HKD5.39 Buy 2013A 2014E 2015EP/E (x) 6.95.04.5EV/EBITDA (x) 6.95.75.5Price/book (x) 0.80.70.6China Railway Group (0390.HK),HKD3.83 Hold 2013A 2014E 2015EP/E (x) 7.56.06.2EV/EBITDA (x) 7.36.97.2Price/book (x) 0.80.70.6China Rail Construction (1186.HK),HKD6.86 Hold 2013A 2014E 2015EP/E (x) 7.55.75.7EV/EBITDA (x) 4.64.04.0Price/book (x) 0.90.70.7Source: Deutsche Bank CRCC and CRG's share prices are up 23-26% in the past two months, on CRC's increased 2014 rail investment budget, potential pick-up in new railway orders and accelerating industry reform. However, we are worried about their 2015 outlook due to a lackluster rail construction business and uncertainty in the property segment. We expect their 2015 earnings to fall slightly (16% growth in 2014) after earnings upgrade revisions. We prefer the rail equipment sub-sector on a sustainable healthy earnings outlook in 2014-2016. Promising maintenance services and overseas markets could support their long-term growth. Our order of preference: CSR, Zhuzhou CSR, CCC, CRCC and CRG. Rail constructors: lack of earnings momentum in 2015 We raise our assumption for railway infrastructure capex during 2014-2015 by 24%, mainly supported by government support for railway industry reform. More private investors might be involved in railway investment. However, we believe 2014 will be the peak year due to a gradual drop in the number of newly-started projects, CRC’s greater emphasis on project profitability and completion of the major railway national network in the coming one to two years. We forecast railway infrastructure spending to rise 17% yoy in 2014, but drop 2% in 2015 and 4% in 2016. Accordingly, we raise our 2014-2015E earnings for CRCC and CRG by 5% and 6% and increase their target prices, but maintain Hold ratings. We expect CRCC’s and CRG’s net profit to drop 1-2% in 2015E from 16% growth in 2014E due to an unexciting railway business (contributing c.35-40% of CRCC and CRG’s net profit) and an uncertain property development business (c.25% of CRCC and CRG’s net profit). Among constructors, CCC is our preferred stock due to its cheapest PE valuation (5x FY14E) with highest dividend yield (5%), good risk control and lowest exposure to the property business (less than 1% of profit exposure). Rolling stock players: healthy outlook could be sustainable We lift our rail equipment spending assumption by 10% for 2014-2015 and expect it to register a CAGR of 20% over 2013-2015E. This increase mainly reflects accelerating investment and stronger traffic growth on high-speed trains. We believe the healthy outlook should be sustainable as: 1) economic recovery and railway reform may support better traffic growth; and 2) an encouraging outlook for maintenance service and overseas could support long-term growth. We raise CSR’s and Zhuzhou CSR’s 2014-2015E earnings by 2% and 3% on average due to CRC’s higher investment in rolling