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2018 Rail Equipment Sector Outlook

Nov 17, 2017 Equity Research | Rail Equipment

Positive (upgraded) Re-rating ahead amid recovery in China’s rail equipment market

Dominic Chan, CFA, FRM SFC CE No. APP609 [email protected] +852 3719 1218 GF Securities (Hong Kong) Brokerage Limited 29-30/F, Li Po Chun Chambers 189 Des Voeux Road Central Hong Kong

Length of newly operational rail lines likely to rebound next year According to the

13th Five-Year Plan, the operating length of rail lines in China should reach 150,000km in 2020, meaning it will need to increase by 23,500km during 2018-20 in order to meet the target. We expect the length of newly operating rail lines to reach ~5,500km in 2018, up from ~2,500 km in 2017, and therefore believe demand for rail equipment will increase. We estimate FAI in the rail equipment sector will increase from Rmb92bn in 2016 to Rmb120bn in 2018, representing 14% of total rail-related FAI in China. EMU procurement to speed up China Railway Corporation (CRC) has procured 257

EMU units YTD, compared with 105 units in 2016. We are now more optimistic on EMU procurement than previously as: 1) we expect the length of newly operational rail lines in China to increase to ~5,500km in 2018; 2) EMU density is likely to increase, driven by a rise in the EMU maximum speed to 350km/hour, and; 3) more EMUs will enter stage C5 of train maintenance. Urban transit development to continue apace According to the China Association of

Metros (CAMET), new urban transit lines with an operating length of 247km began operation in 1H17. In addition, urban transit lines with an operating length of 381km went into construction during 1H17. This suggests that urban transit development remains robust. We continue to expect urban transit operating length to increase from 3,728km in 2016 to 7,173 in 2020, meaning a CAGR of 16.7% during 2015-20. This will lift demand for urban transit vehicles, for which we expect a CAGR of 17% during 2015-20, in terms of units sold, while we forecast the signaling and control system market size will rise at a CAGR of 20% during the period. Brighter outlook for the railway maintenance market We expect both the train

maintenance and railway maintenance market to see faster growth next year. The number of EMUs entering stage C5 of train maintenance will double to 200 units next year, according to CRRC’s management. Meanwhile, we believe railway maintenance vehicle procurement will rise in 2018, in line with the rise in new rail lines. CRRC (1766 HK, Accumulate) and CRRC TE (3898 HK, Accumulate) are our top picks CRRC’s and CRRC TE’s share prices have risen 5.6%/13.5% YTD,

underperforming the Hang Seng index. Given a recovering rolling stock market in China, we expect a re-rating in 2018.

Risks: Reliance on CRC procurement; 2) lower-than-expected rail equipment FAI; 3)

delays in rapid transit project construction; 4) delays in receivable collection from clients.

Sector stock picks

Sources: Company data, Bloomberg, GF Securities (Hong Kong) Note: Calculated based on closing prices on 10 Nov 2017

Company Ticker Rating Price

(HK$)

Target

price

2017E EPS

(Rmb)

2018E EPS

(Rmb)

2017E

P/E

2018E

P/E

2017E

P/B

2018

P/B

CRRC 1766 HK Accumulate 7.35 8.0 0.51 0.60 14.2 12.0 1.53 1.42

CRCCE 1786 HK Accumulate 2.51 3.2 0.16 0.32 15.2 7.6 0.56 0.53

CRRC Times Electric 3898 HK Accumulate 44.65 49.2 2.89 3.24 15.1 13.4 2.48 2.16

CRSC 3969 HK Buy 6.16 6.9 0.47 0.53 12.7 11.3 1.87 1.62

mailto:[email protected]

Nov 17, 2017

2

2018 Sector Outlook

Recovering China rail equipment market

According to the 13th Five-Year Plan, the operating length of all rail lines and high-speed lines in

China should reach 150,000km and 30,000km respectively in 2020, meaning they will need to

increase by 23,500km and 6,500km respectively during 2018-20 in order to meet the target. We

expect the length of newly operating all rail lines to reach ~5,500km in 2018, up from ~2,500 km in

2017, and increase to 8,000km and 10,000 km in 2019 and 2020 respectively.

Key rail lines that will go into operation in 2018 are listed below, including the Shenzhen-Moumia

line, and the Hong Kong section of the China high-speed rail network.

Figure 1: Key rail lines that will go into operation in 2018

Sources: GF Securities (Hong Kong)

Figure 2: Length of newly operational railways (km) Figure 3: Length of railway in operation (km)

Sources: CRC, Wind, GF Securities (Hong Kong) estimates

Driven by more rail lines going into operation, rail equipment FAI in China will increase. During the

12th Five-Year Plan period (2011-15), the length of railways newly brought into operation

increased steadily from 2,174km in 2011 to 9,531km in 2015. Accordingly, investment in the rail

equipment industry rose from Rmb104.9bn in 2011 to Rmb140bn in 2015.

Rolling stock procurement slowed in 2016 due to an expected drop in rail lines being brought into

operation in 2017 (to just 2,500km, in our view). Rail equipment FAI in China declined from

Rmb140bn in 2015 to Rmb92bn in 2016. Meanwhile, rail equipment FAI as a proportion of total

rail sector FAI fell from 17% in 2015 to 11.5% in 2016.

Railway line

Operation

commencement date

Operating length

(km)

Shenzhen-Moumia railway ( Zhanjiang to Moumia) Jun-18 120

Harbin-Jiamusi rapid railway Jun-18 343

Afuzhun Railway Sep-18 428

Hangzhou-Huangshan high-speed railway End-18 265

Harbin-Mudanjiang passenger dedicated line End-18 293

China high speed railway Hong Kong section Dec-18 26

Liuzhou-Zhaoqing railway 2018 414

2,174

5,389 5,586

8,427

9,531

3,281 2,500

5,500

8,000

10,000

0

2,000

4,000

6,000

8,000

10,000

12,000

Nov 17, 2017

3

2018 Sector Outlook

However, China’s rolling stock market is expected to turn around. FAI in rail equipment in China is

expected to rise to Rmb120bn in 2018, and to account for 14% of total rail FAI. Meanwhile, we

estimate that rail equipment FAI will rise to Rmb160bn in 2020 and account for 18% of total rail

FAI, similar to the proportion in 2014.

Figure 4: Rail equipment FAI in China (Rmb bn) Figure 5: Total rail sector FAI (Rmb bn)

Sources: CRC , Wind, GF Securities (Hong Kong) estimates

Figure 6: Annual passenger volume in China Figure 7: Rail freight volume in China


104.9

90.0

103.8

146.5 140.0

92.0

110.0 120

144

160

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

16.0%

18.0%

20.0%

0.0

20.0

40.0

60.0

80.0

100.0

120.0

140.0

160.0

180.0

2011 2012 2013 2014 2015 2016 2017E 2018E 2019E 2020E

Rolling stock investment in China (Rmb Bn) As % of railway sector FAI

590.6 634.0

665.7

808.8 823.8 801.5 800.0 800.0 847.1

888.9

0.0

100.0

200.0

300.0

400.0

500.0

600.0

700.0

800.0

900.0

1000.0

8.7%

11.0%

4.4%

9.3%8.8%

4.6%

10.7%9.5%9.9%

11.0%

9.2%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

0

500

1,000

1,500

2,000

2,500

3,000

3,500

Rail passenger volume (m trips) YoY %

5.9%8.1%

3.7%0.8%

11.5%

6.5%

-1.8%-0.4%

-4.7%

-11.6%

-2.3%

3.7%

-15.0%

-10.0%

-5.0%

0.0%

5.0%

10.0%

15.0%

0

500

1,000

1,500

2,000

2,500

3,000

3,500

Rail freight volume (m tonnes) YoY %

Nov 17, 2017

4

2018 Sector Outlook

Figure 8: EMU density (units per km) Figure 9: Density of freight wagons (units per km)


China’s rail network carried a total of 2.7bn passenger trips during 2016, up 11% YoY; the CRC

estimates this could increase by 9.2% to 3.0bn passenger trips in 2017. However, the

procurement of EMUs dropped to 105 sets in 2016 despite a higher passenger volume.

We believe additional rail equipment demand will come from an increasing density of MUs and

freight wagons. The density of MUs (i.e. the retained number of MUs per km of high-speed rail)

currently stands at 0.95, which is not sufficient to support the continuously increasing length of

newly operational high-speed rail and growing passenger volume.

We believe MU density should be increased in order to catch up with growing passenger volume,

and estimate that MU density will rise from 0.95 per km for high-speed rail in 2016 to 1.12 per km

in 2020.

Meanwhile, the density of freight wagons (calculated as the total retained number of freight

wagons divided by the length of railways in operation) declined to 6.4 per km in 2016. In fact, the

rail freight transport industry in China has been recovering after suffering a double-digit decline in

rail freight volume in 2015. Rail freight volume also declined 2.3% YoY to 2.65bn tonnes in 2016;

the CRC expects this figure to rise 3.7% YoY to 2.75bn tonnes in 2017.

Thanks to improving rail freight volume, the procurement of freight wagons has already increased

from 11,315 units in 2015 to 25,279 units in 2016. We believe demand for freight wagons will

continue to increase in 2017, with density edging up to 6.7 per km.

0.60

0.70

0.80

0.90

1.00

1.10

1.20

No. of MUs per km of HSR in operation

4.85.05.25.45.65.86.06.26.46.6

Density of rapid transit vehicles (units per km)

Nov 17, 2017

5

2018 Sector Outlook

Figure 10: Retained number of EMUs (units) Figure 11: Retained number of locomotives (units)


Figure 12: Retained number of freight wagons (units) Figure 13: Retained number of passenger cars (units)


China Standard EMUs (CSEMU), also known as Fuxing, with a maximum speed of 350km/h, were

put into operation in 2017. CRRC says it will design other new Fuxing products, including

CSEMUs with a maximum speed of 250km/h, and with a maximum speed of 160km/h in 2018.

The CRC has announced three major procurement batches of 50, 104 and 75 CSEMU units

respectively this year, and has therefore announced procurement of 257 CSEMU units YTD. We

expect CRC to procure 400 CSEMU units in 2018.

Meanwhile, procurement of locomotives and freight wagons rebounded in 2017, but CRRC’s

management expects procurement of these products to remain stable in 2018.

Nov 17, 2017

6

2018 Sector Outlook

Figure 14: Procurement of MUs Figure 15: Procurement of locomotives

Sources: CRC, Wind, GF Securities (Hong Kong)

Figure 16: Procurement of passenger cars Figure 17: Procurement of freight wagons

Sources: CRC, Wind, GF Securities (Hong Kong)

Stable rapid transit market

Development in the rapid transit segment has been faster than for rail lines, with the length of

rapid transit lines in operation increasing in recent years. Given the pipeline for projects ahead, we

estimate demand in the rapid transit market will be relatively stable in 2018.

While the length of rapid transit lines increased at a CAGR of 16.7% during 2010-15,

corresponding passenger volume grew at a higher CAGR of 20% during the same period. This

also compares with a 19% CAGR in the retained number of rapid transit vehicles in China during

the period to 19,941 units at the end of 2015.

The current density of rapid transit vehicles is around 6.2 units per km. We believe this figure will

increase going forward to support faster passenger volume growth. Assuming vehicle density will

increase slightly and based on our assumption for the length of rapid transit in operation, we

expect the total retained number of rapid transit vehicles to grow at a CAGR of 18.4% during

2015-20.

Nov 17, 2017

7

2018 Sector Outlook

Figure 18: Length of newly operational rapid transit lines (km) Figure 19: Retained number of rapid transit vehicles


Figure 20: Density of rapid transit vehicles

Sources: SCI Verkehr, GF Securities (Hong Kong)

Brighter outlook for the rail maintenance market

There are five states of MU maintenance: stages C1 and C2, which are referred to as “routine

maintenance”, and C3 to C5, known as “advanced maintenance”.

The rolling stock refurbishment market in China is split between CRRC and the CRC, with the

CRC mainly responsible for stages C1-C3 of EMU maintenance, and CRRC mainly responsible

for stages C4-C5.

1,471 1,699 2,058

2,408 2,816

3,195 3,728

4,534

5,411

6,129

7,173

0

200

400

600

800

1,000

1,200

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000 Rapid transit in operation

Newly operational rapid transit (RHS)

14.6 15.7 17.0

18.9 21.4

24.7 27.5

30.5

34.1

37.9

41.1

0.0

5.0

10.0

15.0

20.0

25.0

30.0

35.0

40.0

45.0

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016E

2010-2015 CAGR 12%

Nov 17, 2017

8

2018 Sector Outlook

Figure 21: Five stages of EMU maintenance

Sources: An Introduction to High-Speed Rail (4th edition) (《高速铁路概论（第 4版）》), GF Securities (Hong Kong)

Figure 22: China’s train maintenance market (Rmb bn)

Sources: SCI Verkehr, GF Securities (Hong Kong)

China’s rolling stock refurbishment market has maintained steady growth since 2010 due to the

increasing number of trains in use: the market was worth Rmb21.4bn in 2010 and grew at a

CAGR of 12% during 2010-15.

The China Railway Construction Investment Company typically issues two invitations to tender

each year for the provision of MU maintenance services. Two such invitations to tender were

issued in 2015, concerning the advanced maintenance of 213 sets of EMUs; another two

invitations were issued in 2016 for the advanced maintenance of 276 MU sets. The first invitation

to tender for this year has been issued for 398 EMU sets, almost double the number in 2015.

The retained number of MUs in China rose to 2,263 sets in 2016. Given increasing MU numbers

ahead, we expect the train maintenance market in China to achieve double-digit growth over the

coming few years. In addition, the number of MUs entering stages C4-C5 of train maintenance will

double to ~200 units in 2018, according to CRRC’s management.

Models CRH1 CRH2 CRH3 CRH5

C1 after 48 hours of operation after 48 hours of operation upon completion of every trip upon completion of every trip

C2 after 15 days of operation after travelling 0.03m km or 30 days of operation after travelling 0.02m km after travelling 0.06m km

C3 after travelling 1.2m km after travelling 0.45m km or 1 year of operation after travelling 1.2m km after travelling 1.2m km



14.6 15.7 17.0

18.9 21.4

24.7 27.5

30.5

34.1

37.9

41.1

0.0

5.0

10.0

15.0

20.0

25.0

30.0

35.0

40.0

45.0

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016E

2010-2015 CAGR 12%

Nov 17, 2017

9

2018 Sector Outlook

Demand for rail maintenance vehicles to rebound

The procurement of rail maintenance vehicles (large-scale track maintenance series and catenary

work car series) has declined since 2014, mainly due to the slowdown in new rail lines going into

operation.

The total number of large-scale track maintenance series units procured by the CRC declined

from 271 in 2014 to 108 units in 2016, while the number of catenary work car series units dropped

from 180 in 2014 to 25 units in 2016. However, procurement of catenary maintenance vehicles

began to rebound in 2017, with the CRC ordering 67 units YTD. We expect total procurement of

catenary work car and large-scale track maintenance series units to increase in 2018 as more rail

lines go into operation.

Figure 23: Track maintenance vehicle procurement (units, 2014-16) Figure 24: Catenary maintenance vehicle procurement (units, 2014-16)

Sources: CIRC, GF Securities (Hong Kong)

China rail control system to maintain double-digit growth

The rail sector is driven by growth in related fixed asset investment, trains (rail equipment), and

rail control systems (rail equipment).

Growth in the rail control system sector is expected to outpace fixed asset investment growth:

investment in rail control systems in China is expected to grow at a CAGR of 13.9% during 2015-

20, compared with a CAGR of 5% for rail FAI.

Figure 25: Market size of China’s rail control system industry during 2015-20 (Rmb bn)

Figure 26: Rail FAI in China during 2015-20 (Rmb bn)

Sources: CRSC, GF Securities (Hong Kong)

2015-2020 CAGR 13.9%

2015-2020 CAGR 5%

Nov 17, 2017

10

2018 Sector Outlook

The rail control system market in China can be divided into three segments: new system

installation, system maintenance and system upgrades. All three segments should post strong

growth given the continued expansion of the domestic rail network.

Figure 27: Market size of China’s rail control system industry by segment during 2015-20 (Rmb bn)

Sources: CRSC, GF Securities (Hong Kong)

Fierce overseas market competition

CRRC is the world’s largest rail equipment company, Bombardier transportation is the second

largest, followed by Alstom Transport and Siemens Mobility. Bombardier Transportation and

Siemens Transport are said to be setting up a JV for their rail signaling and rolling stock divisions,

in order to compete against CRRC.

Overseas business development for Chinese rail equipment companies has not been satisfactory,

with relatively slow growth and the segment representing a relatively small proportion of overall

revenue. We see fierce overseas competition as the main reason for this.

Figure 28: Top 10 rail equipment companies in 2016

Sources: Bloomberg, GF Securities (Hong Kong)

Nov 17, 2017

11

2018 Sector Outlook

Figure 29: Revenue contribution from overseas markets (2014-1H17)

Sources: Company data, GF Securities (Hong Kong)

2017 rail equipment sector performance

CRRC TE (3898 HK) has been the best performer in the rail equipment sector, with its share price

up 13.5% YTD, while CRSC (3969 HK, Buy) is up 10.2% and CRRC (1766 HK) is up 5.6%.

CRCCE (1786 HK, Accumulate) underperformed, mainly due to delays in rail maintenance vehicle

procurement by the CRC.

Figure 30: Rail equipment names performance in 2017


Nov 17, 2017

12

2018 Sector Outlook

Figure 31: Valuation comparison

Sources: Bloomberg, GF Securities (Hong Kong) Note: Updated as of Nov 10, 2017

EPS Market cap

Ticker Company Ccy Price 2016 2017E 2018E CAGR 2016 2017E 2018E 2016 2017E 2018E (US$ m)

HK peers

1766 HK CRRC CORP LTD - H HKD 7.35 0.48 0.52 0.61 13% 15.3 14.2 12.0 1.49 1.53 1.42 44062.52

1786 HK CRCC HIGH-TECH EQUIPMENT C-H HKD 2.51 0.36 0.17 0.33 -5% 6.9 15.2 7.6 0.61 0.56 0.53 488.90

3898 HK ZHUZHOU CRRC TIMES ELECTRI-H HKD 44.65 2.84 2.96 3.33 8% 15.7 15.1 13.4 2.66 2.48 2.16 6726.26

3969 HK CHINA RAILWAY SIGNAL & COM-H HKD 6.16 0.41 0.48 0.54 15% 15.1 12.7 11.3 2.04 1.87 1.62 6942.18

390 HK CHINA RAILWAY GROUP LTD-H HKD 6.06 0.60 0.74 0.83 17% 8.6 8.1 7.3 0.87 0.81 0.74 27950.33

1186 HK CHINA RAILWAY CONSTRUCTION-H HKD 9.5 1.20 1.35 1.50 12% 7.5 7.0 6.3 0.81 0.76 0.69 23060.37

1800 HK CHINA COMMUNICATIONS CONST-H HKD 9.21 1.24 1.35 1.51 10% 7.1 6.8 6.1 0.76 0.74 0.67 31374.00

Average 10.9 11.3 9.2 1.32 1.25 1.12

A shares peers

601766 CH CRRC CORP LTD-A CNY 10.91 0.48 0.49 0.57 9% 29.1 26.4 22.7 2.66 2.66 2.46 44053.95

300011 CH BEIJING DINGHAN TECH-A CNY 13.82 0.25 0.38 0.65 62% 105.5 42.5 25.2 2.99 3.10 2.81 1161.72

601002 CH GEM-YEAR INDUSTRIAL CO -A CNY 10.86 0.11 - - --- 53.4 - - 3.50 - - 1295.35

002296 CH HENAN SPLENDOR SCIENCE&TEC-A CNY 8.97 0.26 - - --- 50.8 - - 2.14 - - 508.38

300150 CH BEIJING CENTURY REAL TECHN-A CNY 6.41 0.20 - - --- 39.7 - - 2.33 - - 564.35

600495 CH JINXI AXLE CO LTD-A CNY 7.25 0.02 - - --- 187.1 - - 2.80 - - 1318.03

603111 CH NANJING KANGNI MECHANICAL -A CNY 15.79 0.38 0.48 0.62 27% 48.3 38.8 30.0 8.05 6.82 5.73 1754.35

300351 CH ZHEJIANG YONGGUI ELECTRIC-A CNY 18.08 0.53 0.66 0.86 28% 39.7 32.5 24.8 2.52 2.43 2.23 1046.33

Average 69.2 35.0 25.7 3.37 3.75 3.31

International peers

abbn vx equity ABB EUR #N/A N/A - 9.51 10.90 --- - - - - - - -

alo fp equity ALSTOM EUR 34.42 11.24 14.29 16.02 19% 33.7 21.6 19.3 2.05 1.96 1.86 8829.45

bbd/b cn equity BOMBARDIER INC-B USD 3.04 - - 0.52 --- - - 36.6 - - - 5506.36

ge us equity SIEMENS AG-SPONS ADR USD 20.12 6.99 8.36 9.19 15% 19.1 19.1 17.4 2.33 2.42 2.38 177691.02

sie gr equity SIEMENS AG-SPONS ADR USD 123.93 63.96 71.82 77.04 10% 15.9 14.8 13.8 2.31 2.23 2.07 116129.12

Average 22.9 18.5 21.8 2.23 2.20 2.10

EPS P/E P/B

Nov 17, 2017

13

2018 Sector Outlook

CRRC (1766 HK)

Accumulate (maintained)

Target price: HK$8.00

Beneficiary of recovering rolling stock demand

Figure 32: Stock performance Figure 33: Key data

Sources: Bloomberg

Figure 34: Stock valuation


EMU segment starting to recover The EMU segment started to recover during 3Q17, and

management has maintained its guidance for delivery of ~350 EMU units in 2017. They also expect EMU deliveries to increase to 350-400 units in 2018. The EMU segment should begin to recover. Concerns about EMU pricing pressure alleviated The CRC and CRRC are said to have agreed

to cut CSEMU purchase prices by 5% in Sept 2017. The two companies have also signed a strategic cooperation agreement to deepen relations in train manufacturing, maintenance and R&D. Management is confident that the EMU price cut will not be a trend, and they are aiming to maintain a stable GPM in the EMU segment. Increase in profitability a surprise GPM widened from 21.5% in 3Q16 to 23.4% in 3Q17, mainly

due to: 1) the expansion in segment GPMs, including those for rapid transit vehicles and freight wagons, thanks to enhanced economies of scales; 2) a change in product mix, where the contribution from the low-margin modern services segment has declined while that from higher-margin locomotives has increased. Internal restructuring to speed up As per our recent note issued after a visit to the company, we

believe CRRC’s internal restructuring process will speed up. It has been reported that CRRC has outlined a restructuring plan for its freight wagon segment recently. We believe its profitability will improve further by consolidating excess capacity, after the internal restructuring plan is issued. Maintain Accumulate and TP of HK$8.00 We expect CRRC to deliver flattish YoY net profit

growth in 2017. As such, we expect the company to have a strong 4Q17, considering its delivery schedule (we estimate 25% YoY revenue growth and 27% YoY net profit growth in 4Q17). More importantly, we expect momentum to pick up in 2018, with net profit growing by 13%. We maintain our Accumulate rating and our DCF-based target price of HK$8.00, representing 16.9x 2017E P/E and 14.5x 2018E P/E.

0

5000

10000

15000

20000

25000

30000

35000

6

6.5

7

7.5

8

11/11/2016 2/11/2017 5/11/2017 8/11/2017

1766 HK (left) HS index (Right)

Nov 10 close (HK$) 7.35

Shares in issue (m) 4371

Major shareholder CRRCG (54.2%)

Market cap (HK$m) 343,759.23

3M avg. vol. (m) 195.90

52W high/low 6.81/7.99

Revenue

(Rmb m)

YoY

(%)

Net profit

(Rmb m)

YoY

(%)

EPS

(Rmb)

EPS

YoY

P/E BPS

(Rmb)

P/B DPS

(Rmb)

Dividend

yield (%)

ROE

(%)

2015 237,785 9% 11,818 9% 0.43 6% 14.4 4.16 1.5 0.15 2.4 12.2

2016 224,138 -6% 11,296 -4% 0.41 -4% 15.0 4.54 1.4 0.15 2.4 10.8

2017E 237,689 6% 11,602 3% 0.40 -4% 15.6 4.24 1.5 0.14 2.2 11.1

2018E 264,750 11% 13,550 17% 0.47 17% 13.4 4.49 1.4 0.16 2.6 12.1

2019E 298,166 13% 15,974 18% 0.55 18% 11.3 4.65 1.3 0.19 3.1 13.8

Nov 17, 2017

14

2018 Sector Outlook

Figure 35: Revenue and net profit (Rmb m) Figure 36: GPM

Sources: Company, GF Securities (Hong Kong)

Figure 37: CRRC’s P/E band Figure 38: CRRC’s P/B band


237,785 224,138

237,689

264,750

298,166

11,818 11,296 11,602 13,550 15,974

-10.0%

-5.0%

0.0%

5.0%

10.0%

15.0%

20.0%

0

50000

100000

150000

200000

250000

300000

350000

2015 2016E 2017E 2018E 2019E

Revenue Net profit Revenue YoY Net profit YoY

Nov 17, 2017

15

2018 Sector Outlook

Figure 39: DCF valuation


Rmb ‘000,000 2016 2017E 2018E 2019E 2020E 2021E 2022E 2023E 2024E 2025E Terminal Value

EBT 16,935 17,062 19,926 23,491 25,840 27,132 28,489 29,913 31,409 32,979

Plus: depreciation 5,244 6,217 6,910 7,279 8,007 8,407 8,828 9,269 9,733 10,219

Plus: interest income/expenses (984) (1,354) (1,382) (1,426) (1,569) (1,647) (1,729) (1,816) (1,907) (2,002)

Less: tax (3,025) (3,071) (3,587) (4,228) (4,651) (4,884) (5,128) (5,384) (5,654) (5,936)

Less: capex (10,032) (9,508) (10,590) (11,927) (10,000) (10,000) (10,000) (10,000) (10,000) (10,000)

Less: working capital (10,091) (2,459) 3,969 928 1,021 1,072 1,125 1,182 1,241 1,303

Free cash flow (1,953) 6,887 15,246 14,117 18,648 20,080 21,584 23,163 24,822 26,563 345,886

Free cash flow PV (1,953) 6,209 12,394 10,347 12,324 11,965 11,596 11,220 10,841 10,460 122,808

WACC calculation

Long-term debt/equity structure 50.0%

Cost of equity

Risk premium 11.0%

Risk-free rate 3.7%

Beta 1.2

Cost of equity 16.90%

Cost of debt

Average cost of debt 6.0% Sustainable growth rate

Effective tax rate 18.0% 8.0 1.50% 2.00% 2.50% 3.00% 3.50% 4.00% 4.50%

Post-tax cost of debt 4.9% WACC 9.40% 8.9 9.3 9.8 10.3 11.0 11.7 12.6

WACC 10.9% 9.90% 8.2 8.6 9.0 9.4 9.9 10.6 11.3

10.40% 7.6 7.9 8.3 8.6 9.1 9.6 10.2

10.90% 7.1 7.4 7.6 8.0 8.3 8.7 9.2

Valuation (HK$ '000) 11.40% 6.6 6.9 7.1 7.4 7.7 8.0 8.4

Long-term tax rate 25% 11.90% 6.2 6.4 6.6 6.8 7.1 7.4 7.7

2020-2025 CAGR 5% 12.40% 5.8 6.0 6.2 6.4 6.6 6.9 7.1

Sustainable growth rate 3%

Free cash flow PV 95,404

Final PV 122,808

Value of company 218,212

Plus/less: 2017 net cash/debt -3,405

Less: minority interests 18,948

Valuation (Rmb$ '000) 195,859

Valuation (HK$ '000) 231,114

Total share capital ('000) 29,066

Target price (HK$) 8.0

Nov 17, 2017

16

2018 Sector Outlook

Figure 40: Financial statements


Year-end Dec 31 (Rmb m) 2015 2016 2017E 2018E 2019E Year-end Dec 31 (Rmb m) 2015 2016 2017E 2018E 2019E

Revenue 237,785 224,138 237,689 264,750 298,166 Prepaid land lease payments 348 364 364 364 364

YoY 8.9% -5.7% 6.0% 11.4% 12.6% Inventories 59,747 54,402 62,615 69,569 78,146

Cost of sales (191,250) (179,110) (190,454) (211,606) (237,693) Trade receivables 72,514 74,053 78,144 87,041 98,027

Gross profit 46,535 45,028 47,236 53,144 60,473 Prepayments, deposits and other

receivables18,787 30,501 29,304 29,014 28,591

GPM (%) 19.6 20.1 19.9 20.1 20.3 Tax recoverable 92 140 140 140 140

Selling expenses (7,954) (7,250) (7,131) (8,472) (9,541) Pledged deposits 4,614 4,561 4,561 4,561 4,561

Administrative expenses (22,486) (22,427) (24,957) (26,475) (29,817) Cash and cash equivalents 34,755 41,034 36,387 39,250 40,746

Other income 3,642 4,017 4,041 4,501 5,069 Total Current Asset 205,526 220,953 225,338 241,617 263,627

Other gains and losses (1,695) (1,623) (951) (1,588) (1,491) PPP 62,180 66,364 70,002 74,294 79,565

Operating profit 18,042 17,745 18,238 21,109 24,693 Prepaid land lease payments 14,428 14,492 14,492 14,492 14,492

OPM (%) 7.6 7.9 7.7 8.0 8.3 Other intangible assets 3,260 2,820 2,820 2,820 2,820

Interest income - - - - - Loans & advances to customers 171 203 203 203 203

Finance Costs (1,412) (1,264) (1,651) (1,713) (1,799) Available-for-sale investments 3,157 3,819 3,819 3,819 3,819

Share of results of an associate 419.0 453.4 475.4 529.5 596.3 Deferred tax assets 2,744 3,009 3,090 3,442 3,876

Profit before taxation 17,048 16,935 17,062 19,926 23,491 Total non current assets 106,168 117,357 121,076 125,719 131,425

Income tax expense (2,951) (3,025) (3,071) (3,587) (4,228) Total Assets 311,694 338,311 346,414 367,336 395,052

Effective tax rate 17.3 17.9 18.0 18.0 18.0

Non-controlling interests 2,279.5 2,614.3 2,388.7 2,789.6 3,288.7 Trade payables 83,179 91,950 93,922 98,556 110,706

Net profit 11,818 11,296 11,602 13,550 15,974 Other payables 41,245 38,217 41,743 46,379 52,097

YoY 9.3% -4.4% 2.7% 16.8% 17.9%Interest bearing bank and other

borrowings15,260 27,184 27,854 29,247 30,709

Retirement benefit obligations 352 320 320 320 320

Tax payable 1,534 1,272 1,536 1,793 2,114

Provisions for warranties 2,280 1,866 1,866 1,866 1,866

Current portion of LT payables 77 91 91 91 91

Total current l iabilites 169,091 184,227 191,733 204,972 227,482

Retirement benefit obligations 4,054 3,516 3,328 3,177 3,280

Deferred tax l iabilities 242 236 236 236 236

Defferred income 5,556 5,945 5,945 5,945 5,945

Total non current l iabilites 29,028 30,279 31,315 31,761 32,491

Year-end Dec 31 (Rmb m) 2015 2016 2017E 2018E 2019E

Equity 96,900 104,857 104,418 111,656 116,132

Pretax Income 17,048 16,935 17,062 19,926 23,491 Non-controlling interests 16,674 18,948 18,948 18,948 18,948

Depreciation & amortization 6,217 6,910 7,279 7,709 8,065 Total equity 113,575 123,805 123,366 130,604 135,080

Other non-cash adjustments (8,283) (2,858) (5,620) 266 (3,440) Total equity and liabilities 311,694 338,311 346,414 367,336 395,052

Net cash from operating activities 14,982 20,986 18,721 27,901 28,116

Capital expenditures (7,387) (10,032) (9,508) (10,590) (11,927)

Other investing activities 1,995 (14,677) (7,751) (7,751) (7,751) Year-end Dec 31 2015 2016 2017E 2018E 2019E

Net cash from investing activities (5,392) (24,709) (17,258) (18,341) (19,677) EBITDA margin (%) 10.2 11.0 10.7 10.9 11.0

Dividends paid (734) (4,093) (4,061) (4,742) (5,591) EBIT margin (%) 7.6 7.9 7.7 8.0 8.3

Changes in debt (10,015) 8,321 1,895 1,990 2,089 NPM (%) 5.0 5.0 4.9 5.1 5.4

Changes in capital stocks 0 0 0 0 0 ROA (%) 3.9 3.5 3.4 3.8 4.2

Other financing activities (5,938) (2,921) (4,430) (4,430) (3,927) ROE (%) 12.2 10.8 11.1 12.1 13.8

Net cash from financing activities (16,687) 1,306 (6,596) (7,183) (7,429) Debt/equity ratio (%) (17.2) (11.2) (6.9) (7.7) (7.4)

Net change in cash (7,090) (1,930) (4,647) 2,863 1,496 Account receivables turnover days 145 180 200 200 200

Cash at beginning of year 37,034 29,944 28,014 23,367 26,230 Inventory turnover days 114 111 120 120 120

Cash at end of year 29,944 28,014 23,367 26,230 27,727 Account payables turnover days 281 306 300 300 300

Income statement

Cash flow statement

Balance sheet

Financial ratios

Nov 17, 2017

17

2018 Sector Outlook

CRRC TE (3898 HK)

Accumulate (maintained)

Target price: HK$49.20

CRRC Group’s internal restructuring to solve intra-group competition issues

Figure 41: Stock performance Figure 42: Key data

Sources: Bloomberg

Figure 43: Stock valuation


3Q17 results below our expectation due to delays in locomotive delivery 3Q17 revenue rose

3% YoY to Rmb3.01bn, but net profit was down 37% YoY to Rmb395m. The decline in net profit was due to a delay in the delivery of locomotives, a decline in GPM caused by a product mix change during the period, and an increase in marketing and R&D expenses due to new business exposure. Railway maintenance machine segment maintains strongest momentum The company’s

railway maintenance machines segment maintained strong momentum in 9M17, with revenue growth beating other segments by rising 70% YoY. Meanwhile, revenue in its marine engineering segment rose 44.5% YoY. Revenue from train-borne systems for locomotives and its rapid transit segment picked up 23.4% and 5.9% YoY respectively, while revenue from train-borne systems for EMUs fell 49.7% YoY. The company’s key electric parts & components segment posted 20% revenue growth, while signal & communication products saw a 3.8% YoY decline. CRRC Group’s internal restructuring to solve intra-group competition issues We believe

CRRC will speed up its internal restructuring process. The company says it will first to deal with the restructuring of its freight wagon segment, followed by locomotives. Restructuring in relation to CRRC TE will also be considered next year. The company will benefit from getting into CNR’s supply chain in the near future. Better 2018 results expected Management has maintained guidance for revenue growth in its

locomotive segment of 50% in 2017, based on its delivery schedule. This means locomotives should see faster growth in 4Q17. Meanwhile, the CRC is likely to speed up EMU procurement as more new rail lines go into operation next year. We therefore expect the company’s EMU segment to bottom out in 4Q17 and post positive growth next year. We expect revenue to increase by 13% and net profit to increase by 12% in 2018. Maintain Accumulate and TP of HK$49.20 The company’s shares have risen by more than 30%

since its interim results announcement. We expect to see faster revenue growth in 4Q17, and a more significant recovery from 2018. We maintain our Accumulate rating and our DCF-based target price of HK$49.20, which represents 16x 2017E P/E and 14.3x 2018E P/E.

Nov 10 close (HK$) 44.65

Shares in issue (m) 547

Major shareholder CRRC Corp (50.16%)

Market cap (HK$m) 52,485.03

3M avg. vol. (m) 123.78

52W high/low 36.5/48.35

Revenue

(Rmb m)

YoY

(%)

Net profit

(Rmb m)

YoY

(%)

EPS

(Rmb)

EPS

YoY

P/E BPS

(Rmb)

P/B DPS

(Rmb)

Dividend

yield (%)

ROE

(%)

2015 14,800 17% 2,965 24% 2.52 24% 15.0 11.92 3.2 0.15 0.4 21.5

2016 14,658 -1% 2,904 -2% 2.47 -2% 15.3 13.66 2.8 0.45 1.2 18.4

2017E 15,959 9% 3,057 5% 2.60 5% 14.5 15.32 2.5 0.52 1.4 17.2

2018E 17,986 13% 3,431 12% 2.92 12% 13.0 17.27 2.2 0.58 1.5 17.1

2019E 20,357 13% 3,882 13% 3.30 13% 11.5 20.15 1.9 0.66 1.7 16.6

Nov 17, 2017

18

2018 Sector Outlook

Figure 44: Revenue and net profit (Rmb m) Figure 45: GPM


Figure 46: CRRC TE’s P/E band Figure 47: CRRC TE’s P/B band


14,800 14,658 15,959

17,986

20,357

2,965 2,904 3,057 3,431 3,882

-5.0%

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

0

5000

10000

15000

20000

25000

2015 2016E 2017E 2018E 2019E

Revenue Net profit Revenue YoY Net profit YoY

Nov 17, 2017

19

2018 Sector Outlook

Figure 48: DCF valuation


Rmb ‘000,000 2016 2017E 2018E 2019E 2020E 2021E 2022E 2023E 2024E 2025E Terminal Value

EBT 3,336 3,531 3,962 4,483 4,931 5,178 5,437 5,708 5,994 6,294

Plus: depreciation 306 321 352 387 425 446 469 492 517 543

Plus: interest income/expenses (12) (24) (36) (54) (60) (63) (66) (69) (73) (76)

Less: tax (418) (459) (515) (583) (641) (673) (707) (742) (779) (818)

Less: capex (1,238) (479) (540) (611) (500) (500) (500) (500) (500) (500)

Less: working capital (637) (528) (45) (545) (600) (630) (661) (694) (729) (766)

Free cash flow 1,337 2,361 3,178 3,076 3,556 3,758 3,971 4,195 4,429 4,676 64,648

Free cash flow PV 1,337 2,138 2,605 2,283 2,389 2,286 2,187 2,092 2,000 1,912 23,927

WACC calculation

Long-term debt/equity structure 50.0%

Cost of equity

Risk premium 11.0%

Risk-free rate 3.7%

Beta 1.1

Cost of equity 15.80%

Cost of debt

Average cost of debt 6.0% Sustainable growth rate

Effective tax rate 15.0% 49.2 1.50% 2.00% 2.50% 3.00% 3.50% 4.00% 4.50%

Post-tax cost of debt 5.1% WACC 9.0% 53.7 55.8 58.2 61.0 64.4 68.4 73.3

WACC 10.5% 9.5% 50.4 52.1 54.2 56.5 59.2 62.4 66.3

10.0% 47.5 49.0 50.6 52.6 54.8 57.4 60.5

10.5% 44.9 46.2 47.6 49.2 51.1 53.2 55.7

Valuation (HK$ '000) 11.0% 42.6 43.7 44.9 46.3 47.8 49.6 51.7

Long-term tax rate 15% 11.5% 40.5 41.5 42.5 43.7 45.0 46.5 48.2

2020-2025 CAGR 5% 12.0% 38.7 39.5 40.4 41.4 42.5 43.8 45.2

Sustainable growth rate 3%

Free cash flow PV 21,229

Final PV 23,927

Value of company 45,157

Plus/less: 2017 net cash/debt 4,123

Less: minority interests 260

Valuation (Rmb$ '000) 49,020

Valuation (HK$ '000) 57,843

Total share capital ('000) 1,175

Target price (HK$) 49.2

Nov 17, 2017

20

2018 Sector Outlook

Figure 49: Financial statements


Year-end Dec 31 (Rmb m) 2015 2016 2017E 2018E 2019E Year-end Dec 31 (Rmb m) 2015 2016 2017E 2018E 2019E

Revenue 14,800 14,658 15,959 17,986 20,357 Bills receivables 3,938 4,259 4,372 4,435 5,020

YoY 16.8% -1.0% 8.9% 12.7% 13.2% Trade receivables 4,763 5,317 5,684 5,913 6,135

Cost of sales (9,138) (9,062) (9,824) (11,203) (12,689) Prepayments, deposits and other receivables 430 347 437 493 558

Gross profit 5,662 5,596 6,136 6,784 7,668 Inventories 3,120 3,239 3,768 4,297 4,867

GPM (%) 38.3 38.2 38.4 37.7 37.7 Other current assets 3,273 2,497 2,713 3,058 3,461

Business taxes and surcharges (103) (111) (128) (144) (163) Cash and cash equivalents 3,500 3,201 4,123 5,839 8,116

Selling expenses (676) (500) (575) (630) (712) Total current assets 19,024 18,860 21,098 24,035 28,156

Administrative expenses (1,667) (1,796) (1,995) (2,158) (2,443) Available-for-sale investments 1 1 1 1 1

Operating profit 3,215 3,189 3,439 3,852 4,350 Long term receivbales 11 50 50 50 50

OPM (%) 21.7 21.8 21.5 21.4 21.4 Long term equity investment 222 229 239 270 305

Other income (83) (268) (287) (324) (366) Fixed aasets 1,815 2,824 3,050 3,315 3,627

Finance Costs 18 (22) (36) (34) (30) Construction in progress 209 192 207 234 265

Non operating profits 186 347 319 360 407 Intangible assets 702 633 686 773 875

Share of results of an associate 121.2 89.7 95.8 107.9 122.1 Development expenditure 1 75 80 90 102

Profit before taxation 3,456 3,336 3,531 3,962 4,483 Goodwill 596 485 417 339 252

Income tax expense (478) (418) (459) (515) (583) Deferred tax assets 293 301 319 360 407

Effective tax rate 13.8 12.5 13.0 13.0 13.0 Other non-current assets 59 73 80 90 102

Non-controlling interests 13.0 14.5 14.1 15.8 17.9 Total non current assets 3,908 4,863 5,129 5,522 5,986

Net profit 2,965 2,904 3,057 3,431 3,882 Total assets 22,932 23,724 26,228 29,557 34,142

YoY 23.8% -2.1% 5.3% 12.2% 13.1% Short term borrowing 165 159 170 192 217

Financial l iabil ites at fair value through

profit or loss0 6 6 6 6

Bil ls payables 1,805 1,835 1,884 2,149 2,433

Trade payables 2,689 2,787 2,961 3,376 3,824

Advances from customers 915 859 958 1,079 1,221

Retirement benefit obligations 53 37 32 36 41

Other payables 581 727 798 899 1,018

Current portion of non-current l iabilities 97 2 53 31 52

Provisions for warranties 368 263 319 360 407

Deferred income 59 77 80 90 102

Total current liabilites 6,732 6,751 7,261 8,218 9,321

Borrowings due after one year 1,211 101 113 128 145

Long term payables 116 101 112 126 142

Provisions 518 339 339 339 339

Deferred income 235 292 319 360 407

Deferred tax l iabilities 102 79 80 90 102

Total non current liabilites 2,182 912 964 1,043 1,136

Year-end Dec 31 (Rmb m) 2015 2016 2017E 2018E 2019E

Equity 13,780 15,800 17,743 20,036 23,425

Pretax income 3,456 3,336 3,531 3,962 4,483 Non-controlling interests 237 260 260 260 260

Depreciation & amortization 291 306 321 352 387 Total equity 14,017 16,060 18,003 20,296 23,685

Other non-cash adjustments (2,250) (1,912) (892) (485) (1,368) Total equity and liabilities 22,932 23,724 26,228 29,557 34,142

Net cash from operating activities 1,497 1,730 2,959 3,828 3,502

Capital expenditures (5,616) (6,831) (5,745) (5,748) (5,136)

Other investing activities 5,022 4,951 4,285 4,285 4,285 Year-end Dec 31 2015 2016 2017E 2018E 2019E

Net cash used in investing activities (594) (1,880) (1,459) (1,463) (850) EBITDA margin (%) 23.7 23.8 23.6 23.4 23.3

Dividends paid (466) (525) (611) (686) (776) EBIT margin (%) 21.7 21.8 21.5 21.4 21.4

Changes in debt 1,174 (1,110) 12 14 17 NPM (%) 20.0 19.8 19.2 19.1 19.1

Changes in capital stocks 0 0 0 0 0 ROA (%) 14.9 12.4 12.2 12.3 12.2

Other financing activities (1,074) 1,110 18 18 382 ROE (%) 21.5 18.4 17.2 17.1 16.6

Net cash from financing activities (366) (525) (581) (654) (377) Debt/equity ratio (%) (25.0) (19.9) (22.9) (28.8) (34.3)

Net change in cash 539 (672) 922 1,715 2,277 Account Receivables turnover days 189 237 240 220 210

Cash at beginning of year 2,215 2,754 2,083 3,005 4,720 Inventory turnover days 125 130 140 140 140

Cash at end of year 2,754 2,083 3,005 4,720 6,998 Account payables turnover days 203 215 220 220 220

Income statement

Cash flow statement

Balance sheet

Financial ratios

Nov 17, 2017

21

2018 Sector Outlook

Rating definitions Benchmark: Hong Kong Hang Seng Index Time horizon: 12 months

Company ratings

Buy Stock expected to outperform benchmark by more than 15%

Accumulate Stock expected to outperform benchmark by more than 5% but not more than 15%

Hold Expected stock relative performance ranges between -5% and 5%

Underperform Stock expected to underperform benchmark by more than 5%

Sector ratings

Positive Sector expected to outperform benchmark by more than 10%

Neutral Expected sector relative performance ranges between -10% and 10%

Cautious Sector expected to underperform benchmark by more than 10%

Analyst Certification The research analyst(s) primarily responsible for the content of this research report, in whole or in part, certifies that with respect to the company or relevant securities that the analyst(s) covered in this report: (1) all of the views expressed accurately reflect his or her personal views on the company or relevant securities mentioned herein; and (2) no part of his or her remuneration was, is, or will be, directly or indirectly, in connection with his or her specific recommendations or views expressed in this research report.

Disclosure of Interests (1) The proprietary trading division of GF Securities (Hong Kong) Brokerage Limited (“GF Securities (Hong Kong)”) and/or its affiliated or associated companies do not hold any shares of the securities mentioned in this research report. (2) GF Securities (Hong Kong) and/or its affiliated or associated companies do not have any investment banking relationship with the companies mentioned in this research report in the past 12 months. (3) Neither the analyst(s) preparing this report nor his/her associate(s) serves as an officer of the company mentioned in this report and has any financial interests or hold any shares of the securities mentioned in this report.

Disclaimer This report is prepared by GF Securities (Hong Kong). It is published solely for information purpose and does not constitute an offer to buy or sell any securities or a solicitation of an offer to buy, or recommendation for investment in, any securities. The research report is intended solely for use of the clients of GF Securities (Hong Kong). The securities mentioned in the research report may not be allowed to be sold in certain jurisdictions. No action has been taken to permit the distribution of the research reports to any person in any jurisdiction that the circulation or distribution of such research report is unlawful. No representation or warranty, either express or implied, is made by GF Securities (Hong Kong) as to their accuracy and completeness of the information contained in the research report. GF Securities (Hong Kong) accepts no liability for all loss arising from the use of the materials presented in the research report, unless is excluded by applicable laws or regulations. Please be aware of the fact that investments involve risks and the price of securities may be fluctuated and therefore return may be varied, past results do not guarantee future performance. Any recommendation contained in the research report does not have regard to the specific investment objectives, financial situation and the particular needs of any individuals. The report is not to be taken in substitution for the exercise of judgment by respective recipients of the report, where necessary, recipients should obtain professional advice before making investment decisions. GF Securities (Hong Kong) may have issued, and may in the future issue, other communications that are inconsistent with, and reach different conclusions from, the information presented in the research report. The points of view, opinions and analytical methods adopted in the research report are solely expressed by the analysts but not that of GF Securities (Hong Kong) or its affiliates. The information, opinions and forecasts presented in the research report are the current opinions of the analysts as of the date appearing on this material only which may subject to change at any time without notice. The salesperson, dealer or other professionals of GF Securities (Hong Kong) may deliver opposite points of view to their clients and the proprietary trading division with respect to market commentary or dealing strategy either in writing or verbally. The proprietary trading division of GF Securities (Hong Kong) may have different investment decision which may be contrary to the opinions expressed in the research report. GF Securities (Hong Kong) or its affiliates or respective directors, officers, analysts and employees may have rights and interests in securities mentioned in the research report. Recipients should be aware of relevant disclosure of interest (if any) when reading the report. Copyright © GF Securities (Hong Kong) Brokerage Limited. Without the prior written consent obtained from GF Securities (Hong Kong) Brokerage Limited, any part of the materials contained herein should not (i) in any forms be copied or reproduced or (ii) be re-disseminated. © GF Securities (Hong Kong) Brokerage Limited. All rights reserved. 29-30/F, Li Po Chun Chambers, 189 Des Voeux Road Central, Hong Kong Tel: +852 3719 1111 Fax: +852 2907 6176 Website: http://www.gfgroup.com.hk

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