China's Rail Rejuvenation Story Awaits a Happy Ending

(Bloomberg Gadfly) -- Five years after two high-speed trains collided in the eastern city of Wenzhou, China's railway companies are making a comeback.

It's not easy to find value after a 51 percent rally in the MSCI China Index during 2017. So lately, sell-side banks have been telling their clients a rail renaissance story. CRRC Corp., the world's largest maker of equipment for railroads, soared more than 20 percent in the last month, closing the first trading day of 2018 at an almost two-year high.

The investment logic is simple: Building a high-speed rail line generally takes four to five years, and the government does not start ordering trains and equipment until about three years into construction. After the July 2011 crash, Beijing froze activity, resulting in a sharp drop in new lines in 2016 and 2017. The program resumed in earnest in 2013, meaning orders are now increasing for the likes of CRRC.

And Beijing seems to be embracing the high-speed concept again. Last July, the national operator China Railway Corp. launched a bullet train named Fuxing, or rejuvenation, which can reach a top speed of 400 kilometers per hour (249 mph), and is the first to be allowed to run above 350 kph since the Wenzhou accident. Shortly after the 19th Party Congress in October, CRC placed two big orders for Fuxing trains.

CRRC, the equipment maker, says it signed contracts totaling 68 billion yuan ($10.5 billion) in the final quarter of 2017. That puts full-year new contracts at around 215 billion yuan, up 30 percent from 2016, according to Morgan Stanley estimates. Almost half of CRRC's sales come from CRC.

Estimated CRRC 2017 new contracts

215 billion yuan

The big lesson mainland investors learned in 2017 was that buying the Beautiful 50 -- blue-chip state-affiliated entities from Kweichow Moutai Co. to Ping An Insurance Group Co. of China -- was a much better bet than crowding into Shenzhen's smaller growth shares. CRRC, with as much revenue as its top four competitors combined, counts as one of those national champions. Indeed, the equipment maker's Shanghai shares are trading at an 76 percent premium to its Hong Kong-listed stock, which is also at a two-year high.

But CRRC is not Moutai, whose rally is backed by strong earnings. While CRRC's operating profit dwindled after the Wenzhou disaster, capital expenditures stayed high. The drinks giant, by contrast, generated more than 26 billion yuan of free cash flow over the last year. 

Let's also not forget the traumatic history of CRRC, formed two and half years ago by the merger of two state-owned rail-equipment makers. Investors who piled in then, hailing China's answer to General Electric Co, saw a $75 billion drop in market value. 

CRRC will need a lot more rejuvenation to regain its 2015 glory.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

Shuli Ren is a Bloomberg Gadfly columnist covering Asian markets. She previously wrote on markets for Barron's, following a career as an investment banker, and is a CFA charterholder.

To contact the author of this story: Shuli Ren in Hong Kong at sren38@bloomberg.net.

To contact the editor responsible for this story: Paul Sillitoe at psillitoe@bloomberg.net.

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