I. Incident Overview

On December 6, the company issued an announcement on investing in the construction and operation of the Sanyo Railway project. The company plans to invest 1.6 billion yuan in three installments by the end of 2021, obtain 13.25% of the shares of Sanyo Railway Project Company, and become the largest shareholder of the project company. It is expected to bring in equipment maintenance revenue of 4.1 billion yuan over the next 3 years of construction plus 1.33 billion yuan of operating revenue and 54 billion yuan of operating revenue of 54 billion yuan and project dividend revenue of 4.5 billion yuan during the 30-year operation period, totaling 69.33 billion yuan.

On December 6, the company issued an announcement on participation in bidding for the equity transfer project of Tianjin Metro Line 2 and Line 3 Rail Transit Operation Co., Ltd. and related line operation projects. The company plans to invest no more than 1.32 billion yuan to form a consortium with Shenzhen Qianhai Xinhai Jintong Investment Partnership to bid for 51% of the shares and 30 years of operation of Tianjin Metro Line 2 and Line 3 Rail Transit Operation Co., Ltd.

II. Analysis and Judgment

The BOT model opens up the full-line operation market for newly built lines, and the TOT model promotes the full-line operation market for existing lines

Since 2017, the company's layout has been transformed into a full-line operator. After 3 years of exploration, the company gradually developed a strategy to open up the entire line operation market for newly built lines using the BOT model and promote the operation market for the entire line of existing lines using the TOT model.

In May 19, the company won the bid for Tianjin Metro Line 7 in the BOT model, marking that the company opened up the entire subway line operation market and achieved a breakthrough from 0 to 1 in the operation of the entire line. Winning the Sanyo Railway project in BOT mode this time marks the company's opening up the entire freight railway line operation market. This time, participation in Tianjin Line 2 and Line 3 under the TOT model marks the advancement of the company's existing operating business into the stock line market.

1. Sanyo Railway BOT Model Project

(1) Equipment supply and services: Revenue of no less than 4.1 billion yuan in 3 years, and estimated additional gross profit of no less than 2.1 billion yuan

Sanyo Railway has now started construction. The construction period is 3 years, and it will be completed in 2023. The announcement estimates that the construction period will bring in equipment supply revenue of 4.1 billion yuan, or about 600 million yuan, 1.65 billion yuan, and 1.85 billion yuan respectively in 20-22, including equipment sales, monitoring and dispatch platform construction, BIM simulation system supply, etc. Based on 50% of the company's gross profit level, it is estimated that it will receive 2.1 billion yuan in gross profit.

(2) Operation: 3-year construction period: 1.33 billion yuan +30-year operation period: 54 billion yuan; labor cost protection clause signed

During the three-year construction period, some sections of the Sanyo Railway line will be completed and operated one after another, with an estimated operating revenue of 1.33 billion yuan. During the 30-year operation period, the operating and maintenance revenue of the entire line was not less than 1.8 billion yuan/year, and the total of 30 years was no less than 54 billion yuan. Furthermore, according to the agreement, the operating and maintenance profit that the company can obtain each year is converted to the number of kilometers of starting operation* reasonable labor costs, which means that the company's operating profit for this project will not be eroded by factors such as labor costs and rising inflation.

(3) Project dividends: not less than 4.5 billion yuan

The Sanyo Railway and the Menghua Railway (Inner Mongolia coal transportation main line) are connected in Sanmenxia, with a total length of 1,100 kilometers to Yangkou Port in the east, and the annual transportation demand reaches 160 million tons. With approval from the National Development and Reform Commission and the Henan Provincial Development and Reform Commission, Sanyo Railway has independent permanent operation rights and independent pricing rights, and the freight rate is set independently at less than 0.35 yuan/ton/km. It is estimated that the average annual transportation revenue from 2023 to 2027 will be about 0.4 billion yuan, and the average annual revenue from 2028 will be about 175 million yuan. The cumulative revenue that the company can enjoy will not be less than 4.5 billion yuan.

2. Tianjin Line 2 and Line 3 TOT Project

(1) The first TOT model project, which is expected to quickly generate revenue from the operation of the entire cable line

The company uses the TOT model to develop the entire existing cable line operation market. Under the TOT model, the company immediately undertakes related work such as operation management, maintenance services, and renovation of the entire line through a small investment, and operating income is expected to increase rapidly.

In this project, the company and its subsidiaries bid for 51% of Tianjin Line 2 and Line 3 shares and a 30-year operating period with an investment of no more than 1.32 billion yuan. During the operation period, the government procurement project budgets for Tianjin Line 2 and Tianjin Line 3 were 27.109 billion yuan and 31,859 billion yuan respectively, totaling 58.968 billion yuan. The government procurement project budget has been approved by the Tianjin Municipal Government and the Tianjin Municipal Finance Bureau.

(2) Intelligent maintenance equipment replacement+new line diversion of old line employees, two measures to reduce urban rail operating costs

Starting with railway equipment, the company provides more than 400 rail transit operation and maintenance equipment products. Its business covers five major fields of expertise: vehicles, signals, lines, power supply, and stations. The company expects to make extensive use of intelligent operation and maintenance products on Tianjin Line 2 and Line 3. On the one hand, it will speed up product iteration and improve product performance, and on the other hand, reduce operating costs through machine replacement. Line 2 and Line 3 already have employees diverted through the newly built Tianjin Line 7. The old line and the new line collaborated to reduce the average labor cost of operating the three city rail lines.

(3) Financial subsidies underpin reasonable returns

This project uses a feasibility gap subsidy method. The return comes from user fees+government financial subsidies, and the financial subsidy underpins the reasonable return of the project.

(4) Focus on building a benchmark project for urban rail operation and establish a long-term demonstration effect

As an essential public transportation service provided by the government, urban rail transit is currently generally in a state of loss, putting tremendous pressure on the finances of local governments at all levels. If the company successfully operates Tianjin Line 2 and Line 3 and successfully reduces subway operating costs, it will establish a long-term and huge demonstration effect throughout the country, which will help the company continue to implement operating orders for the entire city rail line.

III. Investment Suggestions

We believe that the rail transit stock market is huge, and the Shenzhou High Speed Rail, as a market leader after operation and maintenance, will benefit from the trend of increased market concentration after operation and maintenance. Although the full-line operation and maintenance model will face some pressure in terms of capital in the early stages, it will bring about rapid growth in revenue and profits. With the support of “capital increase, credit enhancement, upgrade, and energy enhancement” proposed by the controlling shareholders, we believe that the company is at a new starting point. It is estimated that from 2019 to 2021, the company's net profit attributable to shareholders of the parent company will be 485, 5.99, and 754 million yuan respectively. The corresponding PE will be 22, 18, and 14 times. We will maintain the “recommended” rating.

4. Risk Reminder:

Subsequent new orders fell short of expectations, the repayment cycle was too long, and there was a risk of loss of goodwill.