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Investment in China’s railway sector tipped to fall gradually

Investment in China’s railway sector tipped to fall gradually

Originally published at the South China Morning Post on February 3, 2016.

China’s railway sector is expected to grow more slowly amid continued volatility in the mainland’s economy and emerging market currencies, analysts say.

Growth in fixed-asset investment (FAI) in domestic railways is expected to peak this year and then fall gradually, according to a report this week by Credit Suisse analysts Edmond Huang and Baiding Rong. Investment is expected to reach 3.8 trillion yuan in the 13th five-year development plan, which began this year. That’s about 8.5 per cent more than the 3.5 trillion yuan seen in the 12th plan that finished last year.

Economic growth for the last quarter of 2015 was lower than expected and analysts forecast the economy would slow further this year, with an estimated gross domestic product growth rate of 6.5 per cent year on year. China’s industrial companies would be negatively affected by the weakening of emerging market currencies – which would lower purchasing power in emerging markets – although the impact would not be substantial in the short run, the report said.

“We are turning more cautious on the railway sector,” the analysts said, adding that the sector’s only bright spot would be passenger operators, which could benefit from long-awaited fare increases. “Railway equipment and renewal should grow moderately instead, on the back of the high-speed train networking effect, and rising maintenance and upgrading demand.”

Following good momentum since the second half of 2014, the analysts said railway FAI would rise to 800 billion yuan this year but trend downwards after reaching that peak. Project delays, slow approval of new projects and slow funding may also counteract growth from urban transit investment.

Railway equipment investment is also expected to slow down from this year to 2020, with short-term demand for electric multiple units remaining stable before decelerating, following strong growth in high-speed train operations in the past two years. Weakening cargo transport will also pose strong headwinds for locomotive makers. Despite low margins and downside risks, urban transit vehicles should see strong demand, the report said.

“Overseas development is expected to add new growth to a gradually mature domestic market, but faces execution risks including safety standards, localisation, regulatory and political risks,” the report said. “Emerging currency and bond markets have experienced increasing volatility, which would weaken affordability in the target countries despite the strong commitment of financial support from the Chinese government.”

Analysts said their top stock pick was Guangshen Railway Company. Last month, the company reported an expected 45 per cent to 65 per cent increase in net profit last year. It made about 662 million yuan in 2014.

Beijing will shift investment from construction to maintenance in the 13th five-year plan, according to a report by CLSA analysts Alexious Lee and Nick Feng last month. They recommend CRCC High-Tech Equipment, which they say will receive more revenue contribution from its services business and long-term growth from overseas markets.

“The first round of overhauls for machines sold in 2005-10 started in 2015 and railway maintenance contracting is growing fast with the expansion of CRCCE’s services network,” the CLSA analysts said.

Driven by rising wages and wealth, the penetration rate of passenger rail travel had increased by 8 per cent to 12 per cent over the past three years, the report said, citing data from the National Bureau of Statistics. The boost in interconnectivity would lead to higher demand for maintenance to ensure travel safety.

“The adoption rate of the HSR network is healthy with passenger volume growing 35 per cent annually in 2012 and 2013,” the report said. “There were 570 million passenger trips in 2013 and we expect this number to grow to 1.2 billion by the end of 2016.”

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