SECTOR QUICK COMMENT

During the weekend, Xinhua News reported the dismissal and criminal investigation of Minister of Railway Liu Zhijun. As Liu has been very bullish on high-speed rail, we believe it will be difficult for his successor to be more so. Right now it is hard to evaluate the magnitude of the negative impact, but we believe it affects train makers most, followed by constructors, and lastly CSR Times. We suggest investors take profit here on railway stocks owing to 1) rich valuation 2) potential shrinkage in multiples owing to uncertainty and 3) possible further negative newsflow

Minister of Railway under investigation

Event: During the weekend, Xinhua News Agency reported that Minister of Railway Mr. Liu Zhijun has been dismissed from his position and is now under investigation by the Central Commission for Discipline Inspection of the Communist Party of China, due to " severe violation of discipline" , which is likely to be linked to " corruption" . Prior to his dismissal, Liu spent 10 days travelling across the country to ensure the smooth operations of the railway system during the Chinese New Year period. His downfall came suddenly and unexpectedly, and was followed by the appointment of Mr. Sheng Guangzu as new minister. Mr. Sheng was Minister of General Administration of Customs before this appointment, and was Vice Minister of Railway in 1999. Our view: We believe this news is purely negative for the whole railway sector, as Liu has been extremely bullish on China high-speed railway construction during his tenure since 2003. While already started projects are not likely to be terminated and train procurement orders are unlikely to be withdrawn, the long-term railway development strategy now faces more policy risks, and such uncertainty will be likely to last for at least a few months, which could cause a shrinkage in P/E multiples for the whole railway sector. Best case: The best case, in our view, is that the dismissal of Liu is purely an anti-corruption case, and the new minister will not change the railway development strategy. Alternatively, the reforming of Ministry of Railway during the past decade has lagged, in our view, with an operation style inherited from the central planning economy era. If the new minister embraces some reform, including train ticket pricing, commercialization, etc, such reform may help improve the financial situation of the national railway. However, with the uncertainty overhang for a while, we doubt that such an ideal case is likely to become explicit in the near term. Worst case: The worst case, in our view, is that the new minister might review previous strategy and might significantly slow down the railway construction plan. We believe the long railway construction target should be intact, while the question is whether it will take 10 years or 5 years to construct those railways, which has significant impact on the valuation of railway-related stocks. More importantly, if the procurement of trains becomes more market-driven, railway equipment makers might need to bid more aggressively on pricing to obtain orders, which will cause margins to shrink and hurt their profitability and P/E multiples. Conclusion: We believe this news is negative for the whole railway sector. The impact in order of significance, is CSR/CNR > CRCC/CRG > CSR Times Electric. We suggest investors take profit here and wait for re-entrance after everything becomes more explicit or the share price drops. We believe train makers CSR and CNR face immediate de-rating risk due to their high P/E of 21-22x, followed by railway constructors CRCC and CRG. Zhuzhou CSR Times Electric will face relatively less impact owing to its non-rail-related business, high end manufacturing nature and potential benefit of locomotive and subway investment, in our view.

Valuation