Morningstar | Solid First Nine Month Result on Track to Meet Full-Year Estimate, FVE Maintained at HKD 7.50
No-moat China Railway Group, or CRG, reported a solid nine-month result that is on track to meet our full-year estimate. The company’s revenue expanded by 5% year over year, in line with our estimate. CREC’s net income rose at 19% year on year to CNY 13.2 billion amid gross margin expansion from its core infrastructure operation. We maintain our fair value estimate of HKD 7.50 or CNY 6.70 per share on the company and consider the current market price fairly valued.In the first nine months, CRG’s overall new contract growth slowed to 6% year on year, broadly in line with what we have seen from its infrastructure peers. Much of the slowdown was caused by a drastic drop in new PPP contracts. With a goal of reducing balance sheet leverage, CRG can no longer take up as much debt to finance PPP projects called forward by debt-saddled local governments. We are also starting to see signs that construction companies are holding back on investing too much into PPP projects with long payback cycles. Even though China has granted its local governments CNY 1.35 trillion in specialty debts (up 69% from 2017’s annual cap) to spend on infrastructure, it appears that large portion of those funds is utilized to pay back past debts as opposed to launching new projects. Since PPP projects often carry much higher profitability for constructors, expected reduction in their top line contribution will most certainly drag down CRG’s margins.
On the cost front, increases in prices for construction raw materials put some pressure on CRG’s bottom line. At the same time, we have also seen compensation per employee rise 10% on average during the first nine months of 2018, leading to a corresponding percentage jump in administrative expenses. We expect a similar level of increase in compensation going forward. According to management, CRG has booked most of its impairments during the first nine months of the year, and there should be much fewer impairment charges in the fourth quarter.
China Railway Group is engaged in infrastructure construction, survey, design and consulting services, engineering equipment and component manufacturing and property development; Through its subsidiaries, Co. is also engaged in the provision of engineering consulting services; construction and survey supervision services; manufacture of bridge steel structures, railway specialized equipment and tunnel equipment; construction management; investment and management; financial trust management; and mining. Co. has 5 business segments: infrastructure construction; survey, design and consulting services; engineering equipment and component manufacturing; property development; and other businesses.
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