Date
23 July 2017
The 'One Belt, One Road' strategy could open up enormous new opportunities for China Railway Group and China Railway Construction. Photo: CNSA
The 'One Belt, One Road' strategy could open up enormous new opportunities for China Railway Group and China Railway Construction. Photo: CNSA

Why a merger of two Chinese railway giants would be sexy

I attended a luncheon with the management of China Railway Group (00390.HK) the other day.

One of the hot topics was how Beijing’s “One Belt, One Road” strategy would benefit the company.

It’s widely expected that the ambitious strategy will cost over US$10 trillion or even US$100 trillion.

The Asia Infrastructure Investment Bank (AIIB) is only raising US$100 billion, of which China accounts for 40 percent.

Therefore, numerous Chinese and foreign companies, government organizations and investment funds may join in later, which could generate enormous business opportunities.

Four Hong Kong-listed railway plays have posted a streak of gains.

CSR Corp. (01766.HK) and China CNR Corp. (06199.HK) rallied strongly after the announcement of their merger.

CSR Corp.’s A shares (601766.CN) rose the 10 percent limit for several days; however, the H shares have risen modestly and lagged far behind.

The price gap between the firm’s A and H shares widened substantially, to nearly 100 percent.

Why are investors hesitant to buy the cheaper H shares?

The price-to-book ratio of railway plays is over 3 times, which looks pretty expensive.

Foreign and Hong Kong investors are more conservative, and that’s why the H shares have lagged far behind the A shares.

Mainland mutual funds will target cheaper H shares if A shares continue to surge.

Therefore, investors should take advantage of the recent corrections in China Railway Construction (01186.HK) and China Railway Group.

China plans to invest 2.8 trillion yuan (US$450 billion) in building 23,000 kilometers of railway in the next five years, the 13th five-year plan shows.

However, the latest economic figures, for March, are worrying.

Exports dropped 14 percent last month from a year earlier, while imports slid 12 percent.

Investment in fixed assets expanded 13.5 percent quarter-on-quarter and 8.5 percent year-on-year.

Domestic demand rose 10.2 percent in March from February, and consumption jumped 10.6 percent year on year.

Industrial production rose 6.4 percent from a year earlier, and the M1  money supply increased 11.6 percent, slowing from 12.1 percent growth in the same period last year.

It remains unclear whether China can sustain 7 percent growth in gross domestic product, as it did in the first quarter.

Railway projects, never sexy, are quite down to earth, executives of China Railway Group said.

However, President Xi Jinping has painted a “Chinese dream” to be realized partly by the ambitious “One Belt, One Road” strategy, which has transformed railway stocks and made them sexy.

That has led to surging stock prices like those of the dot.com stocks in the past.

However, the railway firms’ earnings may never justify their soaring share prices.

The liquidity-driven market bubble may burst at any time.

China Railway Group’s management refused to comment on the possibility of merger with China Railway Construction.

That’s understandable from their perspective, as a tie-up could involve complex issues like the distribution of power and benefits. Who will be the new boss after a merger?

Beijing does not want to see vicious price competition between the two firms, as we’ve seen between CNR and CSR.

The government is studying a merger plan of the railway giants.

When it is launched, it could become a catalyst for their share prices to soar.

Investors should take advantage of short-term corrections.

This article appeared in the Hong Kong Economic Journal on April 17.

Translation by Julie Zhu

[Chinese version中文版]

– Contact us at english@hkej.com

JZ/JP/FL

======================

I’ve joined a luncheon with management of China Railway Group (00390.HK) the other day. And one of the hot topics is how the “One Belt One Road” strategy would benefit the company.

It’s widely expected that the ambitious strategy will cost over US$10 trillion or even US$100 trillion. The Asia Infrastructure Investment Bank (AIIB) only raised some US$100 billion, of which China accounts for 40 percent.

Therefore, a number of Chinese and foreign companies, government organizations and funds may join later, which could generate enormous business opportunities.

Four HK-listed railway plays have posted a streak of gains, in particular the sharp rallies of CSR Corp (01766.HK) and China CNR Corp (06199.HK) after the tie-up announcement.

CSR Corp (601766.CN) has touched the 10 percent limit-up for several days on the mainland, however, the H shares have risen modestly and lagged far behind. Therefore, the price gap between A and H shares have been widening substantially to nearly 100 percent. Why investors hesitate to buy cheaper H shares?

The price-to-book ratio of railway plays stays over 3 times, which looks pretty expensive. Foreign and Hong Kong investors are more conservative, and that’s why H shares have lagged far behind soaring A shares.

Meanwhile, mainland mutual funds would target cheaper H shares if A shares continue to surge. Therefore, investors should capture the recent correction of China Railway Construction (01186.HK) and China Railway Group.

China plans to invest 2.8 trillion yuan to build 23,000 kilometers of railway in next five years, according to the 13th five-year railway blueprint. However, the latest economic figures in March is so worrying. Exports dropped 14 percent in March from a year ago, while imports slid 12 percent.

The fixed-assets investment has expanded 13.5 percent quarter-on-quarter and 8.5 percent year-on-year.Domestic demand risen by 10.2 percent in March from the month before, and consumption jumped 10.6 percent year-on-year. Industrial production rose 6.4 percent in March from a year earlier, and the nation’s money supply M1 has only increased by 11.6 percent, slowing from the 12.1 percent in same period f last year.

It remains unclear whether China could sustain the 7 percent GDP growth as in the first quarter.

Railway projects are never sexy and quite down-to-earth, according to executives of China Railway Group. However, President Xi Jinping has painted a “China Dream” with the ambitious “One Belt One Road” strategy, which has made railway stocks so sexy. That has led to surging stock price as the same in dot.com stocks.

However, the company earnings may never justify the soaring share price. The liquidity-driven market bubble may get burst anytime.

The management refused to comment on the possibility of merger between China Railway Construction and China Railway Group. That’s understandable from their perspective, as the tie-up could involve complex issues like power and benefits distribution. Who will be the new boss after the merger?

The two companies are facing the similar dilemma, and Beijing do not want to see vicious price competition between them as we’ve seen in CNR and CSR. The government is studying on a merger plan of the two, but has not kicked off yet. That could become a catalyst for their share prices. Investors should take advantage of short-term corrections.

This article appeared in the Hong Kong Economic Journal on April 17.

Translation by Julie Zhu

[Chinese version中文版]

–Contact us at english@hkej.com

JZ/JP

Founder and Managing Director of Pegasus Fund Managers Ltd.

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