China Rail Sector: New orders to lift E&C sentiment; rolling stock names lack catalysts

Deutsche Bank Markets Research Asia China Transportation Road / Rail Industry China Rail Sector Date 14 July 2016 Recommendation Change New orders to lift E&C sentiment; rolling stock names lack catalysts Stay positive on E&C, Buy CCC/CRCC; CRCCE-preferred stock within producers ________________________________________________________________________________________________________________ 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) 057/04/2016. Phyllis Wang Research Analyst (-) - - phyllis.wang@db.com Key Changes Company Target Price Rating 1800.HK 11.97 to 12.08(HKD) - 1186.HK 11.15 to 11.84(HKD) - 0390.HK 6.73 to 6.93(HKD) Hold to Buy 3898.HK 51.11 to 45.23(HKD) Buy to Hold 1766.HK 7.03 to 6.58(HKD) - Source: Deutsche Bank Top picks China Comms Construct (1800.HK),HKD8.68 Buy China Rail Construction (1186.HK),HKD9.74 Buy CRCC High-Tech (1786.HK),HKD3.87 Buy Source: Deutsche Bank Companies Featured China Comms Construct (1800.HK),HKD8.68 Buy 2015A 2016E 2017E P/E (x) 8.8 6.7 6.1 EV/EBITDA (x) 8.8 7.6 6.7 Price/book (x) 0.7 0.8 0.8 China Rail Construction (1186.HK),HKD9.74 Buy 2015A 2016E 2017E P/E (x) 9.4 8.1 7.1 EV/EBITDA (x) 5.0 4.0 3.7 Price/book (x) 0.9 0.9 0.8 CRCC High-Tech (1786.HK),HKD3.87 Buy 2015A 2016E 2017E P/E (x) 8.6 9.5 8.2 EV/EBITDA (x) 3.7 5.3 4.6 Price/book (x) 1.1 0.9 0.8 Source: Deutsche Bank Constructor share prices have corrected 11% in the past quarter on market concerns about potentially lower government spending, led by a shift in policy stance from aggressive easing towards neutral. However, we believe that market concern was overdone, on the evidence of the acceleration in constructors' new orders and healthy growth of transport FAI in 2Q16. We expect orders from infrastructure projects to maintain strong momentum in the coming months. We still like constructors and CCC and CRCC are our top picks. We turn less positive on rolling stock names, on weak rail equipment investment. CRCCE is our preferred stock among equipment producers. Constructors: better orders; 1H16 results are key short-term catalyst We expect CRG and CRCC to record over 20% growth in 2Q16 new contract value (vs. 16-20% yoy in 1Q16), beating our expectation, primarily due to the urban transit and property development businesses. For CCC, we estimate a recovery in 2Q16 new orders, to grow 15% from 1Q16 (2% yoy) with healthy performance in the dredging and investment business. Good funding and government policy may continue to support solid order performance. We raise our assumptions on CRCC, CRG and CCC’s new contract value by 4-6% in 2016-2017. The three constructors are to release 1H16 results in late August. We forecast their 1H16 net profit to grow over 10% yoy. Raising earnings/TP; upgrading CRG; CCC and CRCC are top picks We raise 2016E-2017E earnings by 3% on average for constructors, mainly reflecting higher order assumptions. After the revisions, we forecast a 12-13% CAGR in their earnings in 2015-2017. We upgrade CRG to Hold from Buy on the likelihood of a better domestic construction business as well as an attractive valuation. Nearer term, we prefer CRCC due to strong 2Q16 new orders, solid earnings growth, healthy balance sheet and relatively cheap valuation (cheaper than CRG). CCC is our medium-to-long-term top pick as it is a prime beneficiary of the OBOR plan and has excellent risk management in overseas markets. It has the cheapest valuation in the sector. Equipment: risk down the line in 2016-2017; prefer maintenance machinery Weak truck traffic clouded the demand outlook for locomotives and freight wagons. Hence, we lower our 2016-2017 railway equipment investment assumptions by 4%. We believe that the synergy from the CSR/CNR merger might be smaller than our expectation, based on our latest discussion with management. We cut CRRC’s 2016-2017 earning by 4% but raise Zhuzhou CRRC’s 2016 earnings by 6% on better margin expansion. We maintain our Hold rating on CRRC, but downgrade Zhuzhou CRRC to Hold from Buy due to its weaker medium-term outlook (caused by potentially smaller order size from CNR). CRCC High-Tech (CRCCE) is our preferred stock within the equipment segment due to its strong earnings growth (benefitting from healthy demand for rail maintenance machinery) and attractive valuation. Valuing railway companies on DCF; ris