China CNR(6199.HK):IPO Preview

China CNR (6199.HK)is the world’s largest rolling stock manufacturer and solutions provider (also the No. 1 manufacturer of electric locomotives and metro cars globally and China’s largest rolling stock manufacturer) with a wide range of productmix such as high-speed multiple units (MU) (24.7% of FY13 total revenue), locomotives (16.3%), passenger coaches (8.3%), freight wagons (13.7%), rapid transit vehicles (6%), railway engineering machinery (1.3%) and modern service business (23.5%).

Valuation。

Based on data complied by Bloomberg, thenet profitis estimated to jump 19% yoy to RMB4.9bn with estimated EPS of RMB0.47 (~HK$0.583), which is equivalent to estimated 8.6X-10.6X FY14E P/E, below industry peer CSR’s(1766.HK) 12.1X. Based onitsA-share closing at RMB4.70 on 12 May, the H-share offer price is roughly 14% below the A-share price (~6% premiumifthe offer price is setat the upper limit).

Investment Positives。

Railway industry backed by supportive policies:China’s investment target on railway infrastructure rose to RMB800bn in 2014 and the year 2014 and 2015 are the peak deliveryperiod of MU train sets. Both China CNR and CSR are China’s leading rolling-stock manufacturers and each has ~50% of the market share and they are poised to benefit from rising railway investment.

Wide range of products with competitive edge in high-tech products:China CNR won bids for 66%, 53.2% and 47.8% of total number of MUs, locomotives and freight wagons with a maximum operating speed over 300km/h. The R&D strength is reflected byitsnew speed record at 487.3km/h as the world’s highest speed in the MUs, design of 350km/h Low Temperature EMUsas well as R&D and manufacturing of maglev trains.

Profit margin improving:Gross margin increased to 17.2% in 2013 from 14.3% in 2012 and it further rose to 20.6% in 1Q14, mainly driven by improved product mix and technological innovation.

Key Concerns。

ChinaRailway Corp.(CRC)accounted for ~50%of total sales of China CNR (FY13: 48.5%) and CRC’s high debt burden may erode its repayment ability; China CNR’s receivables turnover daysjumped 25 days to 103 days in 2013.

Net gearing ratio(Debt-to-equity ratio)remains high though it fell to 55.7% in 2013 from 70.4% in 2011. China CNR plans to cut debts by spending 20% of IPO proceeds on repayment of bank loans.

Ratings Summary。

Fundamentals & Valuation:The increaseinChineserailway investment target in 2014suggested the railway industry is backed by the government policies. China CNR is the market leader that may benefit from the peak deliveryperiod of MU train setsin 2014 and 2015 and the below-peer P/E may also present a good opportunity for subscription.

Anticipated Short-term Price Performance:The volatile marketin May could weaken the short-term performance uponlisting in Hong Kong, but positive fundamentals and reasonablepricing may be supportive for potential upside.