China has long depended on railways as a primary means of long-haul transport. It remains one of the major modes of transport in the present day, with significant growth in railway passenger and freight traffic over the years (Chart 1). As the Chinese government continues to ramp up on railway infrastructure spending in the country, construction companies that specialise in railway infrastructure, such as China Railway Construction Corporation (HKEX.1186), will certainly be amongst the beneficiaries.
Chart 1: Significant Growth In Railway Traffic Over The Years
Dominant Position In China's Railway Construction Market
China Railway Construction Corporation (CRCC) is one of the largest engineering and construction companies in China, specialising in railway construction. It has participated in the construction of almost all the nation's railway lines since 1948, during which CRCC was the railway arm of the People's Liberation Army, with its rail-related businesses historically constituting about 40% of total revenues. The company is currently 55.7% owned by CRCCG, which is itself a state-owned enterprise.
CRCC is also one of the duopolies in China's railway construction market, commanding a market share of about 45 – 50%, with its main competitor being China Railway Group (HKEX.390). China Communications Construction (HKEX.1800) and Metallurgical Corporation of China (HKEX.1618) have also been tapping into rail projects in bids to expand their construction businesses, but so far, they have not been able to make any inroads into the railway construction market as entry barriers are high due to the rigorous safety requirements, accreditations and experience, all of which take years to acquire.
While CRCC specialises in railway construction, it has branched out into other business segments over the years, including non-railway construction projects (expressways, housing, municipal works and hydropower facilities); survey, design and consultancy services; manufacturing of track maintenance equipment; property development; and logistics and materials trading (Chart 2). CRCC has also been expanding its footprint beyond the shores of China, with presences in 112 countries across the globe, and is slowly becoming an integral part of the business.
Chart 2: Revenues Anchored By Construction Segment
A Potential Upcycle In China's Railway Industry
A huge expansion in China's railway infrastructure is underway: under the 13th five-year plan (2016 – 2020), the Chinese government plans to have 150,000 km of railway lines by 2020 – that's an 18.1% increase from the current 127,000 km (as of end-2017). While China intends to invest steadily in rail transport development, with about 4,000 km of new rail lines planned this year, it has to add about 19,000 km of new rail lines over 2019 – 2020 in order to deliver on its railway investment targets – more than double the length of new rail lines launched over the past two years (Chart 3)!
Chart 3: China's Railway Investment To Pick Up Over Next Two Years
The country also plans to expand its high-speed railway (HSR) network to 30,000 km by 2020, connecting more than 80% of major cities in China (with population of more than 1 million). While 25,000 km of HSR lines have already been built – suggesting limited growth potential over the next few years – the government is committed to expanding the HSR network to 45,000 km by 2030 to enhance inter-city connectivity, especially in the less developed western region where HSR construction has lagged behind (Chart 4). China's urban rail trackage, which is estimated to reach 7,000 km by 2020 (up from the current 5,000 km), is also a future area of growth as the country looks to ease congestion and pollution in urban areas.
Chart 4: HSR Construction Has Lagged Behind In The Western Region
In order to deliver on the targets set out in the current 13th five-year plan, China is expected to pick up the pace of its domestic railway infrastructure development in the years ahead, and that could spur a potential upcycle in the railway industry. It is worth noting that China has always delivered on its railway development targets in previous five-year plans, and there are usually fewer tenders in the first two years of the five-year plan. Given its dominant market position, we believe that CRCC will be one of the main beneficiaries of this upcycle, with new railway construction projects coming on-stream helping to drive earnings growth at CRCC over the next few years.
Favourable Long-Term Prospects For Rail Infrastructure
Despite the substantial investment already channelled towards railway construction, China's railway infrastructure remains under-developed relative to developed nations. In 2016 alone, China's locomotives travelled 1,258 billion passenger-km and 2,379 billion freight tonne-km, constituting about a third of the world's total traffic despite accounting for only 12.1% of the global railway network. At 127,000 km, China's railway network density is also much lower than most of its developed peers despite having a much larger population (Chart 5), a sign that railway investment could continue to pick up.
Chart 5: China's Railway Density Much Lower Than Developed Nations
Moreover, rail has a lower carbon footprint compared to other conventional modes of transport, like road or air travel (Chart 6 and Chart 7), and will sit perfectly with China's commitment to substantially scale up pollution control in the country. As such, we believe that rail remains integral to China's long-term transportation plans, and is likely to be well-supported by the government as China expands its transportation network to cope with the demands of a growing economy and rising urbanisation.
Chart 6: Amount Of CO2 Emitted By Various Modes Of Passenger Transport
Chart 7: Amount Of CO2 Emitted By Various Modes Of Freight Transport
Overseas Expansion And Large Order Backlogs Supplement Future Growth
The rising contribution of CRCC's overseas business, which generally has better margins and earnings potential relative to the domestic market, will also drive future share price performance as CRCC continues to expand its presence in overseas markets. In recent years, CRCC has managed to bag major railway construction contracts, such as the successful bidding for the second phase construction of a railway project in Nigeria for approximately USD 1.473 billion (first phase was also awarded to CRCC for USD 823 million).
CRCC will also benefit from the Chinese government's aggressive push to promote its ambitious "One Belt One Road" (OBOR) initiative, which aims to connect Asia, Europe, the Middle East and Africa with a vast logistics and transport network using roads, ports, railway tracks and airports. On its part, China has pledged billions of dollars to be invested in infrastructure projects in countries along the OBOR trade routes. As countries move to strengthen their commercial and diplomatic ties with China, we expect to see more overseas orders flowing in for CRCC.
In addition, CRCC has a large order backlog of RMB 2.18 trillion (as of 30 September 2017) that will provide earnings visibility for the next 2 – 3 years. Its backlog-to-sales ratio has also been on the rise (Chart 8), indicating that the company has not only been able to increase its sales, but has also been able to replace its order backlog with new contract wins.
Chart 8: Backlog-To-Sales Ratio On The Rise
Share Price Has Potential For Re-Rating
Given the expected turnaround in China's railway industry over the next few years and the favourable long-term investment prospects for railway construction, we believe CRCC's share price has the potential for further re-rating. We prefer CRCC over China Railway Group (CRG) due to its larger exposure to railway construction projects and cheaper valuations. CRCC currently trades at an estimated EV/EBITDA ratio of 7.3 that is lower than both CRG and the peer average of 9.4 (Table 1).
Table 1: Valuations Of China's Construction Companies
Company |
*PE Ratio |
PB Ratio |
*EV/EBITDA |
Net-Debt-To-Equity (%) |
China Railway Construction |
5.6 |
0.72 |
7.3 |
77.3 |
China Railway Group |
6.6 |
0.79 |
9.0 |
54.8 |
China Communications Construction |
5.6 |
0.74 |
10.0 |
103.8 |
Metallurgical Corp of China |
5.4 |
0.64 |
12.6 |
95.0 |
China State Construction |
7.8 |
1.73 |
8.0 |
44.2 |
Average |
6.2 |
0.92 |
9.4 |
75.0 |
Source: Bloomberg, iFAST Compilations
*Based on consensus estimates for 2018, as of 6 Feb 2018 |
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Assuming an EV/EBITDA ratio of 8.165 (average of CRCC and China Railway Group) and an estimated EBITDA of RMB 40.9 billion, we arrived at an equity value of RMB 184.9 billion after adjusting for total debt, preference shares, as well as cash and short-term investments. With 21 billion outstanding common shares, CRCC's value per share is about RMB 8.82 (approximately HKD 11), implying an upside potential of about 22.9% based on its last traded price of HKD 8.95 (as of 6 February 2018).
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