Market Calls

PUBLISHED : Monday, 12 September, 2011, 12:00am
UPDATED : Monday, 12 September, 2011, 12:00am


It has been a difficult eight weeks for the China Railway Construction Corporation (CRCC /1186). The firm builds and maintains rail lines on the mainland. Following the high-speed rail collision near Wenzhou, Zhejiang, on July 23, the central government suspended construction of new rail projects, and the accident threw into question the viability of the mainland's ambitious programme. Its share price is down 61 per cent for the year.

On August 30, the firm released decent first-half results, registering a 7.7 per cent growth in profits on robust revenues. But all eyes are on an independent report on the accident, due by the end of this month.

Gary Wong (Guotai Junan) has a somewhat positive view of the counter. He maintains an accumulate rating on CRCC. Usually that is polite language for 'sell', but in this case it seems genuinely to mean what it describes.

'The current [share] price takes into account the risks and the negative impact [of the Wenzhou crash]. The price is not demanding,' says Wong.

Wong has done a sum-of-the-parts valuation of the firm and estimates that it is trading at a 20 per cent discount to its fair value. He also notes that the firm has modest gearing (its total debt to equity is about 60 per cent), which will put it in good position to ride out any downturn.

'The fundamentals of passenger travel and freight have not changed ... They are positive for the development of the industry,' says Wong. 'The impact of [negative] sentiment is only short term.'

Mark Po (UOB Kay Hian) is putting a lot of weight on the independent report to get a sense of China's commitment to spending on rail infrastructure. There is a strong expectation that the government will clarify its investment targets for the rail sector, with clear implications for CRCC.

The government is also investigating allegations of corruption in the industry, which will also have a big impact on its investment plans.

'Last year, 700 billion yuan [HK$853 billion] was spent on rail construction [on the mainland],' says Po. 'For 2012, nobody has a clue on what will be spent.'

Jack Xu (SinoPac) notes CRCC is trading below book value, and he sees few catalysts to boost the share price significantly. 'There is little to drive out the negativity; there are so many negatives,' says Xu.

In light of the collision and corruption allegations, Xu expects a lot of rail infrastructural projects to continue to be delayed. Although CRCC remains committed to massive projects, the fear is that the state will refuse to keep paying for large projects that are in progress and leave CRCC holding the bag.

Meanwhile, Xu says the firm has high labour costs and commitments to pay for raw materials such as steel, cement and petrol.

'We might see the firm's gross margins surprise investors on the down side. The earnings outlook might be bleak,' says Xu.

Xu adds that China's Ministry of Railways has liquidity issues, with its cost of debt rising in the wake of the collision, which has affected its ability to pay for new projects.

The views stated here are those of analysts, and are not stock calls by the South China Morning Post