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Morningstar | Daqin’s Decent 2018 Performance In Line; Safety Checks at Coal Mines Lead to Weak 1Q

Despite economic swings and aggressive railway investments in China, Daqin Railway, or Daqin, has generated substantial free cash flow of CNY 73 billion in total over the past decade, as well as maintaining a generous dividend payout ratio that has consistently exceeded 50%. We think Daqin’s high-quality well-located coal-rail assets and favorable regulatory supports should help the company maintain stable coal-transport volume over the next decade. In addition, its robust cash flows, coupled with lower capital needs, raise the possibility of higher dividend payouts, which is an added attraction for shareholders.Daqin is one of the few net profitable rail operators within China’s national railway system, and has long benefited from China’s coal-transport bottleneck. Its core asset, the Daqin Line, is China’s premier and busiest “west-east coal rail corridor,” connecting China’s coal capital Datong in Shanxi to Qinhuangdao Port. We think Daqin’s strategic location with access to Qinhuangdao Port, which is important as the barometer of China’s coal demand and prices, leads to a virtual monopoly. This, along with Daqin’s cost advantage and high operating efficiency, should help the company to defend its leading position in coal rail transportation. Coal rail tariffs are regulated, with base tariffs being set by China’s National Development and Reform Commission. Daqin enjoys a special tariff that is slightly higher than the standard tariff. However, being a national freight rail-operator, Daqin’s responsibility to collect an additional CNY 0.033/ton-kilometer construction fund for the government on top of its special tariff has weakened its cost advantage. The completion of a few new railroads during 2014-15 sent the coal rail network into excess capacity from bottlenecks. Competition has risen, and coupled with coal market headwinds, this should see limited coal-transport volume growth on the Daqin Line. On the bright side, rail transport’s high fuel efficiency makes it a low-carbon option for coal transportation. Hence, we think railways will benefit from China’s antipollution policies, and gradually take over truck-borne transportation in the longer term.