On track for profit

Xi Jinping’s New Year greetings listed three engineering marvels from China in 2019: the Beijing Daxing International Airport (see WiC469), the country’s first homegrown aircraft carrier (the Shandong) and the new Jingzhang Railway.

The third achievement – a 174km long high-speed railway (HSR) – cuts travel times between Beijing and Zhangjiakou (in Hebei province) to 47 minutes, down from more than three hours. It is also said to be the world’s first driverless bullet train system, using the latest technology to both navigate and function.

Yet its inclusion in the top three could also be viewed as rather sentimental. For some Chinese, Jingzhang (the local abbreviation for Beijing-Zhangjiakou) has a special place in their hearts. Commencing operations in 1909, the original Jingzhang train service was the first railroad to be designed, financed and built domestically by Chinese. Defying local doubters and political pressure from foreign powers, Chinese engineers were eventually able to complete the work two years ahead of schedule and comfortably under budget.

While trains chugged along the same route 110 years ago at maximum speeds of 35km per hour, the new HSR boasts a top speed 10 times faster.

This explains Xi’s celebratory mood following the new service’s opening last month: “The Beijing-Zhangjiakou railway line has witnessed the development of Chinese rail, as well as leaps in China’s comprehensive strength,” he said.

After laying more than 35,000 kilometres of HSR track across the country – 70% of the world’s total, according to Xinhua – over the past decade, China’s leadership in bullet trains is beyond question (see WiC440).

Yet railway officials have been given another major task this year: to prove that the rail network can be commercially viable too. And in order to achieve this, they have started 2020 by launching an IPO to take their best railway asset public on the A-share market.

Which is the IPO candidate?

It is the crown jewel of the China State Railway Group (CSRG), a state-owned monopoly set up in 2013 to steward the range of commercial entities after the graft-riddled Ministry of Railways was dismantled.

In its listing prospectus published last week, the Beijing-Shanghai High Speed Railway (BSHSR) said it is planning to raise about Rmb30.7 billion ($4.4 billion) through an initial public offering via the Shanghai Stock Exchange.

According to Xinhua, BSHSR filed its IPO application on October 22, taking just 23 days to get the approval of the China Securities Regulatory Commission – a new record. Its trading debut is ‘on track’ to occur before the Chinese New Year holidays, which commence on January 25.

BSHSR is known locally as China’s most profitable railroad, carrying more than a billion passengers since its launch just under a decade ago. Average passenger numbers have grown 20% annually since 2013 and seat occupancy increased to 78% in June last year, up from 66% when it opened in mid- 2011.

The railway has not only connected the Chinese capital with the country’s most important onshore financial hub, it also links the megalopolis of Jing-Jin-Ji (aka Beijing, Tianjin and Hebei) with the booming cities of the Yangtze River Delta.

In fact, according to a World Bank report in 2014, passengers on the BSHSR’s 1,318km route have, on average, travelled only 500km (i.e. most don’t go the full distance but travel a portion of the route). That means that rather than serving solely as a link between Beijing and Shanghai, the railway’s greatest contribution has been in propelling population flow and economic development in the regions clustered along its network. For instance, the World Bank suggested in 2014 the BSHSR had added almost one percentage point to GDP growth in the cities of Dezhou and Jinan in Shandong province, which are situated at the midpoint of the railway line.

This helps to explain the economic planners’ enthusiasm for HSR track in other parts of the country. “It [BSHSR] covers a densely populated region [up to 27% of the country’s total] with rapid urbanisation and economic development,” Xinhua has suggested. “It is truly a unique and precious asset.”

How is BSHSR being valued?

Since first breaking even in 2014, the company has been profitable for five consecutive years on steadily growing revenues. Its net profit grew 13.2% year-on-year to Rmb10.2 billion in 2018. The company indicates in its listing document that it expects profits grew further to at least Rmb11 billion for 2019.

After setting an offer price at Rmb4.88 a share this week, BSHSR is set to raise about Rmb30 billion by selling 12.8% of its total shares. This equates to a market value of Rmb240 billion, or 23.5 times its 2018 earnings.

Caixin Weekly says that this shows a little flexibility on the CSRC’s part, which usually adheres to a “red line” of capping listing candidates’ offer prices at a price-to-earnings multiple of 23 times. Perhaps that indicates a determination to start 2020 with a bang in the A-share market too, and the apparent willingness to help the rail operator has not gone unnoticed among investors. The BSHSR float will also be one of the largest IPOs in recent years, coming just behind Postal Savings Bank’s $4.8 billion offering in December. It is expected to be one of the most hotly received A-share IPOs in recent memory.

Reflecting the high hopes for a post-IPO price spike, demand from retail and institutional investors saw the IPO oversubscribed 127 times (Postal Bank’s was over-subscribed 79 times). As of Monday, more than 12 million retail investors had expressed an interest in owning the stock. Only 0.79% of them will be awarded a slice of the offering.

The brisk reception has prompted concerns from more cautious commentators, including an op-ed in Sanlian Life Weekly, which asked whether BSHSR’s IPO could “become another PetroChina”. PetroChina, a unit of state-owned oil major CNPC, went public in Shanghai back in 2007 under the halo of being “Asia’s most profitable company”. But for retail investors, it now has a more unpleasant connotation in representing much that is wrong with the A-share market. Debuting at an offer price of Rmb16, PetroChina surged to Rmb46 when trading started. But most of the punters who bought that first day never got a chance to exit with their investment intact. PetroChina’s shares have gone south ever since that opening day. As of this week, they were trading at around Rmb6.

How does the railway line make its money?

The railway firm’s filing points out that its net profit margin reached 32.9% in 2018 and improved to 38% over the first three quarters of last year, booking a net profit of Rmb9.5 billion during that period.

The South China Morning Post went as far as noting that the BSHSR is a better performer (in terms of net profit margin) than some of the world’s most famous brands such as iPhone maker Apple and Kweichow Moutai, which makes China’s most popular baijiu liquor. Such impressive margins normally feed off an efficient cost structure, and one of the more telling figures in understanding the BSHSR’s unusually structured business is the size of its payroll. The operator of China’s busiest rail service employed just 72 staff in 2018 and that number was further reduced to 67 people for the first three quarters of last year. In comparison, Daqing Railway, another Shanghai-listed unit of CSRG that specialises in coal transportation, had nearly 100,000 employees on its payroll at the end of 2018.

“The BSHSR is not a conventional railway firm. It is more similar to an asset management company,” AlphaWorks, a WeChat-based financial news provider, noted approvingly.

The BSHSR actually operates under what is being termed as an “entrusted transportation management model”. Its assets include the railroad and the stations but the operation of these assets – including the larger number of staff needed to provide the train service, as well as maintain the equipment – have been separated from the listing candidate and outsourced to sister firms of the CSRG, the former railway ministry, which remain under state control. Nearly half of BSHSR’s income also comes from its sister firms, which are required to pay a “cross-network fee” should their rail services be connected to BSHSR’s.

As a result AlphaWorks notes that the BSHSR’s income statements comprise a large amount of connected transactions, and that its financial wellbeing rests heavily on the opaque “clearing systems” set by CSRG and the Minister of Finance.

In that light, the commercial prospects of the line are closely linked to how the CSRG and the central government juggle the priorities for the national rail network. For instance, because the BSHSR is running at close to 80% of its capacity, there have been calls from local railway bureaus to divert some of the traffic to their own, alternative routes. Another risk factor for the BSHSR: that a second Beijing-Shanghai high-speed line has already been planned, which would take a route closer to many of the coastal cities. For the time being no one is sure if this new line would become a unit of the BSHSR or a rival firm.

What is CSRG’s plan?

CSRG is huge, with assets on its balance sheet totalling Rmb8 trillion at the end of 2018 (and Rmb5.2 trillion of debt). It paid Rmb806.7 billion in interest payments in the same year. That equates to an interest rate of just 1.6% on average (despite toll road operators generally having to make do with something above 4%).

Yet while it is not that surprising that state lenders are offering the railway monopoly favourable rates, CSRG seems determined to rely more on the equity market to finance its future investment. Significant capital is required: according to Xinhua, China’s annual railway investment has topped Rmb800 billion for six consecutive years and the CSRG is planning to add 2,000km of new high-speed line this year to kickstart the 14th Five-Year Plan.

That’s why the railway monopoly is planning a busy year securitising its best assets, which also means that it is counting on the BSHSR listing to go well. At the group’s annual conference earlier this month, its chairman Lu Dongfu said the IPO of its Beijing-Shanghai line was just the beginning of the fundraising process. CSRG is also working on taking some of its other assets public, including its special cargo services unit and the railcar maker Jingying Heavy Industry and Tieke Shougang Railway Tech, a unit that develops HSR equipment.

“The BSHSR’s listing is a milestone in the process of China’s railway industry reform. It helps promote the mixed-ownership economy in the sector, optimise capital structures and advance the high-quality growth of the railway sector,” Xinhua also applauded this week.

Citing a senior official from the National Development and Reform Commission, Time Weekly added that a number of the other more profitable stretches of HSR line between Beijing-Guangzhou might also go public this year.

Will everything go to plan?

Not everything is rosy for the railway planners. The Haoji Railway is a good example. The 1,800km freight line links Kholbolji in Inner Mongolia with Ji’an in Jiangxi province, running through the middle of the country. It was supposed to spur economic growth in northern China by hauling fossil fuels to more affluent regions further south – a brilliant idea, it would seem, in addressing the twin issues of uneven distribution of energy resources and unbalanced economic development. According to a Caixin Weekly report late last month, services only started in September last year after 10 years of construction costing Rmb193 billion. However, the magazine reports that freight volumes on the new line have been disappointing. The railway was designed to haul more than 200 million tonnes of coal a year, or nearly 550,000 tonnes a day. So far it has been transporting an average 35,000 tonnes on a daily basis.

One worry for potential investors in the BSHSR, the Wall Street Journal reports, is that the Chinese government might eventually decide to draw down profits from its best railway lines to fund lesser-performing ones.

Arguably this is already happening for the BSHSR, which plans to use the entire Rmb30 billion IPO proceeds to acquire a 65% stake in a sister firm that operates several of CSRG’s railway lines in Anhui, one of China’s less affluent provinces. Not all the lines are profitable but the acquisition will still set the BSHSR back Rmb50 billion, meaning that the A-share debutant will need to find other financing for the remainder of its new investment.

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