Railway builders may shift focus home after Africa setbacks

PUBLISHED : Monday, 27 April, 2009, 12:00am
UPDATED : Monday, 27 April, 2009, 12:00am

The two leading mainland rail construction firms, China Railway Group and China Railway Construction Corp (CRCC), are expected to cut back on overseas ventures and focus on their huge domestic market.

The shift in strategy stems partly from Beijing's huge economic stimulus package, but the change also reflects concerns over problems the two state-owned firms face in their multibillion-dollar projects in Africa, analysts say.

The consensus forecast of 23 analysts in a Bloomberg survey is for China Railway's net profit to fall 36.7 per cent to 1.53 billion yuan (HK$1.73 billion) last year then rebound 260 per cent to 5.51 billion yuan this year. Turnover is expected to grow 27.1 per cent to 220.9 billion yuan for last year and a further 27.6 per cent to 281.9 billion yuan this year.

For CRCC, the consensus forecast of 20 analysts is for net profit surging 57.5 per cent to 3.62 billion yuan last year and rising 66.1 per cent to 6.02 billion yuan this year. Turnover is expected to grow 20 per cent to 206.49 billion yuan last year and 24.3 per cent to 256.77 billion yuan this year.

Citigroup has a sell recommendation on CRCC because of weaker margins, as well as on China Railway on profit risks from build-operate-transfer projects and lower margins.

Citi based its lower margin expectations for China Railway on its increasing debt to fund infrastructure projects by the central and foreign governments, customers' higher pricing power and the company's plan to keep a large headcount to minimise unemployment during this financial crisis.

Part of the concern analysts have about both companies stems from their African investments.

In November, Nigeria suspended CRCC's US$8.3 billion rail project, which makes up 14 per cent of the firm's outstanding contracts.

Although the project may possibly be revived, Macquarie analyst Anderson Chow said: 'I don't think the market will expect any contribution from Nigeria. Overseas will be a smaller portion of CRCC's orders. Domestic orders will grow strongly.'

As for China Railway, a recent report by Global Witness, a British non-governmental organisation, expressed concern over a US$9 billion deal between the government of Congo and a consortium of Chinese state-owned enterprises including China Railway.

The deal, signed in April last year, gave China Railway mining rights to cobalt and copper resources in Congo worth US$3 billion, while the mainland firms including China Railway would build infrastructure such as railroads, roads and dams. China Railway, listed in Hong Kong and Shanghai, has a US$3.1 billion capital commitment to Congo.

The deal reportedly required a minimum 19 per cent internal rate of return for the Chinese firms, which some have deemed too high.

China Railway joint company secretary Yu Tengqun said the agreements in Congo were valid, fair and reasonable.

'We heard from China Railway management that they are slowing down their investment in overseas mining ventures and China real estate because of lots of activities in China and the drop in the prices of mining products,' Daiwa Institute of Research analyst Geoffrey Cheng said. 'Their message was they are slowing down their diversification.'

In the past few weeks, China Railway's share price was more resilient than CRCC, Mr Cheng noted. 'This is due to market expectations that China Railway will slow its diversification. The market looks at it as lower-risk compared with CRCC.'

Mr Chow said: 'If China Railway reduces its diversification, it's very good. Its greenfield mining projects are inherently high-risk. For the copper mines in Congo, I don't know if China Railway can predict what returns it can get.'

For China Railway, CRCC and China Communications Construction, Citi analysts Jenny Zhen and Cici Lam forecast in a report a 10 per cent drop in contract wins from overseas in the next year or two largely because of higher financial and execution risks and company plans to focus on domestic railway projects.

China Railway and CRCC can expect many projects on the mainland, where they control roughly 90 per cent of the market.

Beijing plans to nearly double the country's railway spending to 600 billion yuan this year from 330 billion yuan last year, Xinhua reported. This is part of the 4 trillion yuan stimulus plan Beijing announced in November to tackle the crisis.

However, the Citi analysts cautioned: 'There is a misconception that doubled railway investments means doubled railway construction revenue.

'Industry experts have indicated that within the 600 billion yuan, only 420 billion to 450 billion yuan should be contributed to rail engineering and construction work.'

China Railway suffered a net foreign exchange loss of 1.94 billion yuan in the first three quarters last year, so it would not see earnings growth for that year, said Mr Cheng.

'Definitely, the stimulus would benefit both companies... Even though they earn small margins, look at the size and growth of the market.'

Diminished appeal

Citi has a sell on China Railway and CRCC on low margins, profit risks

For last year, China Railway's net profit is tipped to fall 36.7 per cent to, in yuan: yuan 1.53b