China's largest manufacturer of railway line maintenance machinery. CRE equipment was separated from China Railway Construction Corporation (1186 HK, unrated) in 2015. The first equipment was sold in 1989. According to the procurement data of China Railway Corporation and our estimates, the group sold a total of 2460 units of equipment in China from 1989 to 2016, accounting for about 80% of the national sales of such equipment.
Net profit rose only 2.4% in 2016. The delay in China Railway's total procurement led to an 8.9% year-on-year drop in 2016 revenue to 3.6 billion yuan. However, net profit rose 2.4 per cent year-on-year to 467 million yuan, thanks to an increase in the contribution of the high-margin product overhaul business. Gross profit margin rose from 24% in 2015 to 27.3% in 2016, mainly for the following reasons:
1) the gross profit margin of machinery sales in its main business rose from 20.4% to 23.7%. (2) the contribution to product overhaul and spare parts sales increased, both of which had higher profit margins. As the company's shares were diluted after the listing, EPS fell to Rmb0.31, and management recommended a dividend of Rmb0.16 per share, equivalent to a dividend ratio of 52 per cent.
The demand for railway line maintenance machinery is optimistic. According to the 13th five-year Plan, China Railway Master Plan plans to invest RMB 3.5 to 3.8 trillion in railway fixed assets, and its railway operation mileage will increase from 124000 km in 2016 to 150000 km in 2020. At the same time, the number of large-scale railway line maintenance machinery installed in China will increase from 17 per thousand kilometers in 2010 to 28.5 in 2019. The management of railway construction equipment expects that the demand for large-scale railway line maintenance machinery during the 13th five-year Plan period will increase by 40% compared with the 12th five-year Plan period. At the same time, the market for large-scale railway line maintenance machinery will grow from 3.6 billion yuan in 2015 to 5.3 billion yuan in 2019, with a compound annual growth rate of 10 per cent, according to Zhaoshi.
The growth of overhaul services is accelerating. Large-scale railway line maintenance machinery needs to be overhauled every 10-13 years, and about 1300 equipment will be overhauled in the next few years. According to Zhenshi Consulting, China's overhaul market will grow at a compound rate of 19% between 2015 and 2019.
It covers a "buy" rating for the first time, with a target price of HK $4.40. The company's share price fell 34.5% in 2016, mainly due to delays in orders, which we believe has now been reflected in the stock price. However, China Railway is likely to speed up its procurement in 2017. We estimate that the company's EPS in 2017 and 2018 is 0.35 EPS 0.40 yuan, and the compound annual growth rate of EPS in 2017-2018 is 15%. The current share price corresponds to 9 times the 2017 forecast price-to-earnings ratio and a dividend yield of 5%. For the first time, the coverage gives a "buy" rating, with a target price of HK $4.40, based on 11 times 2017 forecast price-to-earnings ratios, in line with railway peer valuations.
Main risks: 1) dependence on China Railway General Purchasing; 2) Railway fixed investment is lower than expected; 3) dependence on major suppliers; 4) potential reduction of cornerstone investors; 5) delay in trade and bill receivables collection.
