China CNR Corporation is into its second week of pre-marketing for a $1 billion to $1.5 billion initial public offering of shares in Hong Kong.
The train manufacturer, already listed in Shanghai, is pitching a 1.82 billion primary share deal, comprising 15% of its enlarged share capital. There is the normal 15% greenshoe and 90%/10% split between institutional and retail investors, and formal roadshows are provisionally scheduled to begin towards the end of the week.
CICC, Macquarie and UBS are acting as joint-bookrunners on the deal and have plenty of sectoral experience since CICC and Macquarie also led the dual Shanghai and Hong Kong IPO for China CNR’s main competitor, CSR Corporation, in August 2008.
China CNR’s IPO is being pitched at 8.76 to 13 times projected 2014 earnings, based on Bloomberg's consensus forecast data. In Shanghai, the group's shares currently trade on a forward P/E ratio of 9.71 times, while CSR Corp's trade slightly higher at 11.01 times, according to Bloomberg.
Both stocks are down so far this year – the former by 8%, the latter by 14.8%. Shares in CSR Corp have also slipped in Hong Kong over the same period but have nonetheless outperformed the Hang Seng China Enterprises Index. The group is also trading on a higher earnings multiple in Hong Kong at 12.66 times expected 2014 earnings.
If current trading levels provide any guide, then China CNR’s H-share issue should come at a premium to its A-shares and at a 12.66% discount to CSR Corp. This would place the deal just above the mid-point of its indicative price range at around 11 times projected 2014 earnings of $765 million.
China CNR’s peers further afield include Alstom, which makes France's high-speed TGV trains and is currently the subject of a takeover bid from US industrial giant General Electric, and Canada’s Bombardier. Alstom is trading at almost 11 times 2014 earnings, while Bombardier's P/E ratio is at 9.61, Bloomberg data shows.
Selling points
CSR Corp’s share price ticked up 2.74% in Hong Kong on Monday after the company released first quarter results. Although these showed a 5% year-on-year drop in net profit to Rmb772 million ($123 million), gross margins improved to 18% from 15.6%.
China CNR’s gross margin stood at 17.2% in 2013, while net profits amounted to Rmb4.2 billion ($676 million), compared with Rmb3.6 billion in 2012 and Rmb3.1 billion in 2011.
Analysts on average are forecasting a further 13% increase in earnings for 2014, although the medium-term outlook depends on state-owned China Railway Corp’s (CRC) tender announcement, which is expected some time in the second or third quarter. This will show the number and type of multiple units (MU) the government plans to take delivery of.
According to CRC figures, China CNR in 2013 manufactured 66% of CRC’s MUs with a maximum speed of over 300 km per hour, 53.2% of its locomotives, and 47.8% of its freight wagons.
China has spent billions on its high-speed rail network, although heavy new supply outweighed demand from 2011 to 2013, impacting stock market valuations. This was further compounded by a high-speed collision on the Yongwen railway line in July 2011, when two trains were derailed, resulting in 40 deaths and nearly 200 injuries. This not only led to sharp declines in ridership but also to a reduction in operating speeds, at the request of the State Council. In addition, there was a halt in high-speed rail construction. New MU orders were shelved and only resumed again in August 2013.
But despite slowing economic growth in China and government efforts to rein in credit spending, analysts are more confident about the next few years.
Fresh signs of government stimulus emerged in the rail sector in mid-March when it was announced that five rail projects worth a total of Rmb142 billion ($22.7 billion) were being fast-tracked. A few weeks later, the government also announced the establishment of a rail development fund worth an estimated Rmb200 million to Rmb300 million per annum.
UBS believes strong government commitment will be one of the key factors keeping China’s high-speed rail network expanding at a fast pace over the next decade. Whereas some analysts believe growth rates will slow, the Swiss bank estimates that China’s railway’s operating length could reach 200,000 km by 2030, up from an estimated 123,000 km in 2015.
Other new earnings streams are also being developed, which should help underpin the sector’s earnings.
Firstly, China's urbanization continues to underpin the development of mass transit systems, even if margins here are lower than in the long-distance, high-speed sector. According to the China Association of Urban Metros, urban track length could expand to 7,000 km by 2020 from about 2,500 km now. As of December 31, there were 87 urban rail transit lines in 19 cities in China, with China CNR’s rapid transit vehicles operating on 48 of those lines, the company’s listing prospectus said.
Secondly, both China CNR and CSR need to maintain the trains they build for China’s fast-growing new track, which should help to smooth out previously volatile earnings streams.
Risks
Both train manufacturers are trying to expand into overseas markets. China CNR’s exports as a percentage of total revenues have averaged 7% to 10% over the past three years.
However, much like the country's food companies, Chinese rail companies have to overcome concerns over their standards. For example, in March, New Zealand’s KiwiRail alleged that trains supplied by China CNR contained asbestos.
An independent examination found that while asbestos materials had not become airborne, there were risks from materials identified in the packing materials around hinges on engine room doors. As a result, roughly 40 locomotives were taken out of commission, although China CNR anticipates that 20 will resume operations by the end of April and the remainder in August.
China CNR plans to use most of the proceeds from its IPO for project development, equipment procurement, research and development, and to repay bank loans.
