ZHUZHOU CRRCTIMES ELECTRIC:Expect modest 1H16earnings growth from a high base

Update from management. YTD MU deliveries have been normal for this time of year. The company’s backlog of c.200 MUs as of end-2015 is scheduled for delivery by 3Q16F, in keeping with company guidance. The company has a positive outlook on urban rail products based on strong recent investment in this area. In our view, the weak link has been the locomotive segment, which has an insufficient backlog and few tenders. In Jun, ZZCRRC acquired the IGBT plant from its parent for c.RMB1.1b. By buying the plant, ZZCRRC may see annual savings in the RMB40m-50m range, as depreciation cost will be lower than rentals. SMD, the company’s deep-sea robotics arm acquired in the UK last year, received its first order in China.

China Standard MU an opportunity for ZZCRRC. ZZCRRC’s revenue from selling components to CNR has been negligible to date.

Management’s focus at the moment is on R&D of new components based on the idea that product tendering for new train models will level the playing field with ZZCRRC rivals who are also supplying CNR. An example of a new train model is the China Standard Electric MU currently undergoing rigorous testing. We think the MU’s design could be finalized by yearend or early next year with the tendering process for the MUs beginning thereafter at CRC’s discretion.

1H16F results: modest growth over a high base. We expect ZZCRRC to report 5% net profit growth in 1H16F following the 42% YoY increase in 1H15. We believe revenue growth from urban rail and MUs will offset a sharp decline in locomotive revenue. Despite an unfavorable change to the revenue mix, we anticipate the company’s gross margin will remain largely stable in light of margin improvement for urban rail products brought by increasing scale and ZZCRRC’s track record for keeping costs down through innovation.

Long-term outlook solid despite near-term uncertainties. We shave our 2016-2018F forecasts by 1-3% after lowering our expectations for the locomotive segment. We also lower our target price by 5% bringing it from HK$60.50 to HK$57.30. ZZCRRC’s fundamentals are strong and it continues to sharpen its competitive edge through R&D and strategic acquisitions; however, share price performance may be buffeted in the near term by disappointing tenders. At 13.4x 2016F P/E, the stock’s valuation is below its historical mean and is, in our view, inexpensive. Maintain Outperform.

Earnings and target price revisions

We reduce our FY2016-2018F net profit forecasts by 1-3% to reflect our lowered expectations for locomotive component sales. We expect locomotive-related revenue to decline 11% in 2016F before resuming single-digit growth in 2017F.

We lower our target price by 5%, bringing it from HK$60.50 to HK$57.30 while keeping it based on the same P/E multiple of 16.5x and a 2017F EPS of RMB2.99. In making our calculation we have also factored in a lower renminbi exchange rate.