China CNR Corporation Limited (6199.HK, Not Rated): IPO Express

The IPO-CNR is a leading global rolling stock manufacturer and solutions provider and was the world’s biggest seller of new rolling stock in 2012 in terms of revenue. The H-share offerwill account for 15% of the enlarged share base (excluding the over-allotment option and share-option scheme). At time of publicationthe firm is expected to list on the Hong Kong exchange on 22 May2014.

Valuation and Recommendation - The HK$5.00-HK$6.20 offer price indicates a market cap of HK$60.7bn-HK$75.3bn, implying 10.0X-12.4X FY14E P/E based on the Bloomberg A-share consensus FY14E net profit of RMB4,895m. The lower-end offer price of HK$5 is around a 14% discount to the price of CNR’s A-shares, which closed at RMB4.66 on 14 May. The lower-end valuation is a 12.3%/18.7% discount to peer CSR’s 11.4X/12.3X in the A-/H-share markets. The discount to peers provides an undemanding valuation in view of CNR’s promising growth prospects over FY14-FY16 (21.5% earnings CAGR for the period vs. CSR’s 14.4%).

Investment Positives:

More railway investment - China has increased its railway investment target three times this year to RMB800bn. Investment in 2014 may reach the peak level of 2010 and remain high during 2015-2016. CNR‘s current order backlog is at a two-year high of RMB81.8bn due to CRC’s resumption of equipment order tenders in late FY13. Delivery should peak in FY14-FY15 and drive earnings growth.

Improving margins - Gross margin improved from 13% in FY11 to 17% in FY13, partly due to lower costs from greater production localization for core components. 1Q14 gross margin increased further to 21%. Costs are expected to fall further as the company improves its competence in core systems, which should make CNR more competitive when bidding for overseas projects.

Railway refurbishments provide sustainable growth - China’s railway network in operation is expected to grow from 103k km in 2013 to 123k km in 2015 for a CAGR of 9.3% (31.3% for high-speed railways). This will require more rolling stock, which will in turn require refurbishment spending in the long term, providing sustainable growth for the railway equipment industry.

Favourable product mix - Railway construction has accelerated in Northwestern China, where trains operate at high altitudes and in extreme weather conditions. CNR currently provides the only MU product, the 350km/h CRH380B, that can operate under such conditions on the Harbin-Dalian high-speed line. This could help it expand market share in western China and be reflected in higher earnings growth for FY14-FY16.

Risks - 1) Less railway investment if CRC’s financial condition worsens; 2) High customer concentration could weaken bargaining power for pricing; 3) Fluctuations in raw-material costs; 4) Political risk from expanding in emerging markets.