Date: 10 October 2024
Broker: OCBC Investment Research
Company Overview
China Railway Group (CRG) is a leading state-owned enterprise in China, focusing on integrated construction services. The company is primarily involved in railway infrastructure, with operations extending to construction, survey and design, engineering equipment manufacturing, and peripheral activities such as property development, materials trading, and mining. It holds a significant market share in China’s domestic railway infrastructure, urban transit infrastructure, and highway infrastructure.
Investment Thesis
China Railway Group is poised to benefit from China’s ongoing economic rebalancing. Infrastructure investments continue to serve as a counter-cyclical tool in response to slower economic growth. The company is shifting its focus to “high-quality” growth projects, with a keen eye on profitability and operating cash flow generation. This pivot aligns with China’s broader state-owned enterprise (SOE) reforms, which prioritize investment returns.
Selective Project Approach
CRG is adopting a more selective approach in its project execution. The company focuses on high-quality projects with better paybacks, rather than pursuing large-scale infrastructure works indiscriminately. While infrastructure remains a key driver for CRG, its shift towards higher-margin, quality-driven projects positions the company well amidst market changes.
Growth in Mining Resources
CRG’s diversification into mining is proving to be a lucrative venture. The company controls or holds shares in the construction of less than 10 mines, both in China and overseas. In the first half of 2024, CRG produced 150,000 tons of copper, 10.7 tons of zinc, 7,700 tons of molybdenum, along with cobalt and silver. The mining business contributed approximately 14% of CRG’s profit in 2023, with its net margin reaching about 21%, making this segment increasingly important for the company’s overall profitability.
Limited Exposure to the Belt and Road Initiative
Unlike some of its domestic peers, CRG has limited exposure to China’s Belt and Road initiative, with overseas sales contributing less than 7% of its revenue since 2010. This is significantly lower than its competitors such as China Railway Construction Corporation (CRCC) and China Communications Construction Company (CCCC). CRG’s primary revenue driver remains domestic contracts, which account for over 90% of its total revenue.
Financial Performance
For the fiscal year ending in 2023, China Railway Group reported revenues of CNY 1,263 billion, with a gross profit of CNY 122.7 billion. Net profit stood at CNY 31.8 billion, and earnings per share (EPS) reached CNY 1.3. The company is projected to maintain steady revenue and profit levels for FY2024 and FY2025. Gross margins are forecasted to stay at 10.2%, while net profit margins will hold at 2.5%. The company’s return on equity (ROE) for 2023 was 10.6%, with projections of 8.5% for both FY2024 and FY2025.
Potential Catalysts
- Faster new order growth: CRG could benefit from an uptick in new contracts, especially if China’s economic conditions necessitate increased infrastructure spending.
- Government fiscal stimulus: If the government chooses to boost infrastructure spending, this could further elevate CRG’s performance.
- Unlocking asset value: CRG could enhance profitability by unlocking value from its existing infrastructure assets.
Investment Risks
- Margin pressure: Higher raw material costs and potential delays in contract payments could pressure CRG’s margins.
- Political and economic uncertainties: CRG’s overseas projects are primarily in developing countries, which come with heightened political and economic risks.
Valuation
CRG is trading at a Price-to-Earnings (P/E) multiple of 9.9 for FY2023, expected to slightly decrease to 9.2 for FY2025. Its Price-to-Book (P/B) ratio stands at 0.4. The stock’s valuation appears favorable compared to its peers, with its dividends per share (DPS) expected to remain stable at CNY 0.21 for FY2023 and FY2025.
Environmental, Social, and Governance (ESG) Performance
CRG’s corporate governance practices lag behind global peers, particularly due to the lack of an independent board majority, which may limit management oversight. The company also performs below industry average in health and safety standards, and there is limited evidence of initiatives to increase investments in clean technology, despite its involvement in wastewater treatment plant construction.
Conclusion
China Railway Group is pivoting toward high-quality growth with an increasing focus on profitability, supported by its diversified mining business. Despite challenges related to raw material costs and political uncertainties in overseas projects, the company’s strong domestic focus and selective project approach offer a stable foundation for future growth. Investors can also look forward to potential benefits from government infrastructure initiatives.
