EUR 850.00 For Business Accounts Only

Morningstar | Daqin’s 3Q in Line; Robust Coal Rail Demand Underpins Solid Earnings Growth

We maintain our fair value estimate of CNY 9.80 per share for narrow-moat-rated Daqin, following its in line third-quarter performance, with net profit rising 9% year-over-year to CNY 3.9 billion. Coal rail-transport demand remains robust, and Daqin saw its daily average volume recovering to 1,263 kilotonnes in September, from 1,209 kilotonnes in August that was affected by 10-day repairs work. We think China’s stricter air-pollution controls will lead to rail transport replacing coal trucks, which will continue to drive robust coal rail-transport volume for Daqin in the coming years. However, with the daily volume of over 1,250 kilotonnes, we think Daqin’s average utilization rate should be well above 95%, meaning further volume upside will be capped by capacity constraint. We maintain both our coal volume assumptions and our earnings forecasts, we expect Daqin’s net profit to grow at a CAGR of 3.2% between 2018 and 2027.

We think the shares are slightly undervalued at the current level, trading at 1.1 times price/book and are lower than their 10-year average of 1.7 times and our valuation of 1.4 times. This reflects market concerns over long-term coal demand and potential volume diversion following the start of Menghua Line slated at end-2019. Although the excess coal-rail transport capacity should see rising competition, we expect Daqin’s dominant position in coal rail-transport, with its cost and structural advantages, especially its access to key coal gateway Qinhuangdao Port, will make it a long-term winner. Its strong market position is reflected in the company’s robust coal volume growth, with cumulative nine-month volume rising 5.4% in 2018, compared with the lackluster 2.8% growth at its key competitor Shuohuang Line. We expect Daqin to maintain a stable coal volume of 440 million tonnes over the midcycle.

Although the capacity constraints and the high utilization rate on Daqin Line should mean a relative low growth outlook for Daqin, we think the company’s robust cash flow and lower capital needs will continue to support more generous dividend payouts, and our estimated 2018 dividend of CNY 0.54 per share implies a 6.8% dividend yield, higher than a typical 4%-6% for its infrastructure and utility peers.

Starting from 2018, the freight railway system has implemented a new settlement measure, which calls for a change of the previous section-fare system to a consignment system, meaning the carrier will receive full fare on its outbound volumes while paying network usage and service fees to the owners of pass-through tracks and arrival stations. The new settlement measure encourages carriers to actively source shipments to achieve higher operating leverage as the outbound carrier would be able to keep more of the far than they do under the section-far system. With outbound volume accounting for about 65%-70% of its total coal shipments, we think Daqin is better positioned to benefit from the change, as higher outbound volumes should bode well for revenue growth, and which will also flatten its cost curve given its operating leverage. We view his as a positive move toward a market-oriented freight rail-transport system.