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China: Machinery: Construction
Constructing for China: 5 initiations – CRCC (Buy), CRG (Sell)
Strong earnings growth fueled by still robust construction cycle
We initiate coverage with Buy ratings on CRCC (1186.HK/601186.SS), Sell ratings
on CRG (0390.HK/601390.SS), and Neutral rating on CCCC (1800.HK). CRCC (A) is
on our Conviction List. We expect CRCC to offer 42% earnings CAGR over 2008-
2010, benefiting from the still booming construction cycle in China. We expect
China to spend about Rmb4.5tn on transportation-related infrastructure
investment over 2008-2010, a 53% increase from 2005-2007.
Railway business is key to margin recovery and earnings growth
We believe government policies in China favor rapid development of a wide
railway network over a highway, due to the former’s greater energy efficiency.
We expect the government to invest Rmb1.2tn on railway infrastructure over
2006-2010E and believe that the government could absorb a part of the higher
construction raw material (e.g. steel) costs, limiting the margin compression for
firms such as CRCC, CRG and CCCC.
Pairs trade: long CRCC (H), short CRG (H); ~40% potential spread
Within our China infrastructure construction coverage, CRCC has: 1) the
highest revenue growth visibility (over 3X unrealized revenue/2008E revenue);
2) the fastest forecast earnings growth; 3) a dominant position in the lucrative
high-speed railway market (43% share); and 4) a growing international business
(150% 2008E revenue growth) which offers further optionality. Our 12-mo TPs for
CRCC of HK$15.0 (H)/Rmb15.4 (A) offer potential share price upsides of 22%/43%.
Catalysts abound from margin improvement and favorable policies
1) Potential upward revision in the high-speed railway cost by the Ministry of
Railway in 2H2008; 2) faster-than-expected margin improvement in the
construction segment; and 3) rising international sales (with higher margins than
domestic contracts) from a very robust backlog (CRCC: 15X 2008E sales). We
believe these catalysts will have a limited impact on our Sell-rated CRG.
Valuation: strong earnings growth should compress P/E fast
CRCC(H) is trading at 32X 2008E P/E. However, as we forecast 53% yoy EPS
growth, we expect its 2009E multiple to fall sharply to 21X . We also expect its
2009E FCF yield rise to 3.3% from -1.6% in 2008. Risks: 1) slower-than-expected
infrastructure construction investment growth in China; and 2) higher-thanexpected
raw material costs.
Table of contents
Robust earnings growth fueled by growing and diversifying markets 3
Premium valuation to global peers reflects stronger earnings growth 6
Snapshot of target prices, EPS estimates 11
Environmentally more friendly railway expansion to boost earnings 11
Emerging markets offer additional areas for demand growth 15
Industry dynamics should become more favorable to contractors 16
Key risks include rising raw material costs and Rmb appreciation 18
CRCC (1186.HK, Buy): Buy on impressive earnings growth 20
CCCC (1800.HK, Neutral): Limited access to the railway market 23
CRG (0390.HK, Sell): Stretched valuation with limited growth 26
Disclosures 29
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