18 September 2018

CNR business booming but it’s not all good news

China North Locomotive and Rolling Stock Industry (Group) Corp. (CNR, 601299.CN) is on a roll, with almost 40 billion yuan (US$6.57 billion) worth of orders from China Railway Corp. and a number of local metro operators under its belt.

That’s the good news. The bad news is its rail projects, largely on a build-transfer (BT) basis, leave it increasingly exposed to the risky construction model. Never mind its recent troubles in Shenyang where it stood to lose massively on a controversial project.

Local governments are enamored with BT because it allows them to sit back and let contractors pick up the tab. Because there are no upfront costs, local authorities are able to continue their spending spree on other pet projects.

CNR and its peers have no such luxury. With thinning margins from selling rail cars, they have turned their business model upside down — they design and build entire railway systems and hand the finished product to customers.

In theory, this is supposed to bring enormous profits to train makers. It rarely does.

Just months ago, CNR tangled with Shenyang authorities over a tramway project it completed on a BT basis.

When the stretched municipal government failed to pay the 4.8 billion yuan bill, CNR was left scrambling for cash. It survived the crunch by the proverbial skin of its teeth.

Shenyang is now a distant memory thanks to a 10 billion yuan subway project CNR won from Chongqing, its single biggest mass transit BT contract. CNR outbid key players including China South Locomotive and Rolling Stock (01766.HK, 601766.CN).

And BT, like it or not, is here to stay.

CNR’s commitment to BT continues to be driven by the theoretical advantages of the business model. As long as it remains popular with local governments, it is expected to offer great opportunities for rail systems builders going forward.

Also, CNR did not come away empty-handed from the Shenyang fiasco. If nothing else, it has learned a lesson in brinkmanship and bolstered its confidence in handling similar problems.

And it did make Shenyang pay. Liaoning province, which has administrative jurisdiction over Shenyang, has agreed to pay the bill by installment and help CNR recoup its costs. 

Shareholders are generally optimistic about the company’s future earnings growth. CNR has to make sure those expectations are not knocked off-track.

– Contact the writer at [email protected]



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