china automation group | 569
TRANSCRIPT
Page 1 of 17
Company Update
5 September 2014
Lewis Pang
(852) 2235 7847
Trading data
52-Week Range (HK$)
3 Mth Avg Daily Vol (m)
No of Shares (m)
Market Cap (HK$m)
Major Shareholders (%)
Auditors
Result Due
1.24/2.03
1.8
1,026
1,632
Mr. Xuan Ruiguo
(45.02%)
Deloltte
FY14: Mar Company description
Listed in 2007, China Automation Group (CAG) is
primarily engaged in petrochemical and railway
industries. It offers two major product categories
for each sector, including 1) safety control
systems and 2) control valves for petrochemical
industry, as well as 3) signaling systems and 4)
auxiliary power supply and traction systems for
railway industry.
Price chart
Positive signals in 1H14 results, initiate BUY Rating BUY Initial
Target price
HK$2.05
Current price
HK$1.59 Upside +29%
19% growth in 1H14 PBT, 2nd
consecutive half-year periods with yoy earnings growth after the downtrend started in 2H11 CAG achieved 19% yoy PBT growth in 1H14, which is the 2
nd
consecutive period with yoy earnings growth, we believe it indicated that CAG is bottoming out from the downtrend started in 2H11. Positive signals in 1H14 results included 1) better costs control (SG&A ratio down from 18.6% in 1H13 to 17.9% in 1H14), 2) lowered net debt position, and 3) no new provision for bad debt.
Railway signaling system: recovery expected in 2H14E, improving new orders While railway signaling system sales dropped by 25% to RMB99mn due to delay of product delivery, management expressed that new orders was improving in 1H14 (~RMB250mn). As China Railway Corporation (“CRC”) generally completes most of the projects in the 2H, CAG expects to achieve ~RMB350mn sales in FY14E. New orders could also get a further boost if CRC accelerates investment to achieve its 2014 spending target of >RMB800bn.
Train electrified equipment show sign of recovery, control valve’s momentum carried on After CRC resumed train tendering in 3Q13, train electrified equipment sales rebounded from RMB64-72mn in the last 3 half-year periods to RMB82mn in 1H14. On the other hand, momentum of control valve segment carried on with 33% sales growth. Management is positive towards its prospect given the fragmented market and stable replacement demand.
Safety control system: improving GPM By terminated the loss making Singapore unit and reduced exposure to non-core and lower margin segment such as products related to oil and gas industry, GPM of safety control system improved from 29% in FY13 to 35% in 1H14. Management would continue to put a higher priority on profitability to achieve ~38% GPM in short term.
Focus on cash flow to lower debt level CAG is focus on improving cash flow in order to reduce debt level. CAG now requires the customers to pay a higher proportion of down payment, and it scale down the equipment distribution segment as this business requires a significant amount of working capital. CAG is making progress with RMB174mn operating cash inflow in 1H14, leading to RMB36mn decrease in net debt position.
The worst should be over, initiate with BUY We believe the worst for CAG should be over, and the potential increase of CRC’s spending in 2H14 would provide a stronger support to CAG in FY15E. Initiate with BUY, target price at HK$2.05, which translate to 10X FY15E PER, a 10% discount to the average of H share railway system and equipment suppliers.
RMB million FY12A FY13A FY14E FY15E FY16E
Revenue 2,211 2,309 2,188 2,361 2,551
Net Profit 85 74 131 167 188
EPS (RMB) 0.082 0.072 0.128 0.163 0.183
P/E ( x) 15.4 17.7 9.9 7.8 6.9
Sources: Bloomberg, CIRL estimates
China Automation Group | 569.HK
Page 2 of 17
Positive signals in 1H14 results
19% growth in 1H14 profit before tax, 2nd
consecutive half-year periods with yoy
earnings growth after the downtrend started in 2H11
While revenue declined by 11%, CAG achieved 19% yoy PBT growth in 1H14, which is
the 2nd
consecutive period with yoy earnings growth, we believe it indicated that CAG is
bottoming out from the downtrend started in 2H11. Positive signals in 1H14 results
included 1) better costs control (SG&A ratio down from 18.6% in 1H13 to 17.9% in
1H14), 2) lowered net debt position, and 3) no new provision for bad debt.
Railway signaling system: recovery expected in 2H14E, improving new orders
Sales of railway signaling system dropped by 25% to RMB99mn, management
attributed it to the delay of product delivery. However, management expressed that new
orders was improving in 1H14 (~RMB250mn), which is higher than the actual sales
figure of all 4 half-year periods during FY12-13. As CRC generally completes most of
the projects in the second half of a year, CAG expects to achieve ~RMB350mn sales in
FY14E. New orders could also get a further boost if CRC accelerates investment to
achieve its 2014 spending target of >RMB800bn.
Train electrified equipment show sign of recovery, control valve’s momentum carried on,
After China Railway Corporation (“CRC”) resumed train tendering in 3Q13, train
electrified equipment sales rebounded from RMB64-72mn in the last 3 half-year periods
to RMB82mn in 1H14. On the other hand, momentum of control valve segment carried
on with 33% sales growth. Management is positive towards its prospect given the
fragmented market and stable replacement demand.
Safety control system: Improving GPM by taking less non-core orders
Revenue of safety control system declined by 17%, but GPM improved significantly from
29% in FY13 to 35% in 1H14. CAG terminated the Singapore unit, which incurred
RMB25mn and ~RMB8mn gross loss in FY13 and 1H14. It also reduced exposure to
non-core and lower margin segment such as products related to oil and gas industry.
Management would continue to put a higher priority on profitability to achieve ~38%
GPM in short term.
Focus on cash flow to lower debt level
CAG is focus on improving cash flow in order to reduce debt level. CAG now requires
the customers to pay a higher proportion of down payment, and it scale down the
supplementary equipment distribution segment as this business requires a significant
amount of working capital. CAG is making progress with RMB174mn operating cash
inflow in 1H14, leading to RMB36mn decrease in net debt position in comparison to 31
Dec 2013.
Page 3 of 17
Exhibit 1: 1H14 results review
Source: CAG, CIRL
RMB mn 1H13 1H14 YoY change Remarks
Sales 1,207 1,071 -11.2%
- safety control systems 539 450 -16.5%CAG ceased taking low margin orders including oversea orders and
orders from non core segment such as oil and gas industry
- control valves 230 304 32.6%Management is positive towards its prospect given the fragmented
market and stable replacement demand (replaced every 3-5 years)
- railway signaling systems 132 99 -25.0% Products delivery is delayed to 2H14
- train electrified equipment 66 82 24.5% Rebounded after CRC resumed train tendering in 3Q13
- engineering & maintenance 73 78 6.7% Stable growth along with accumulated system delivered
- distribution of equipment 167 58 -65.5%
Declined due to 1) CAG scale down this segment to save up working
capital, and 2) change in accounting policy (only net revenue was
booked rather instead of gross revenue for trading contracts)
Gross Profit 421 388 -7.8%
SG&A (225) (192) -14.6% Management is putting more focus on costs control
R&D expenses (42) (45) 6.8% Mainly related to development of high end control valves
Net provision of bad debt (24) 0 -100.0% no new provision for bad and doubtful debts was made in 1H14
Other income/expenses 22 16 -26.1%
Operation profit 152 167 10.0%
Share of associate/JV profit (1) (0) -76.7%
Net finance costs (66) (66) -0.1%
Profit before tax 85 101 18.7%
Income tax (16) (30) 91.6%
Higher effective tax rate as 1) finance costs of the holding company is
not recognised and 2) expiry of tax holidays for some subsidiaries.
Management is looking for better tax planning in 2H14
Profit 69 71 2.1%
Non-controlling interest (4) (2) -33.3%
Net profit 66 68 4.1%
GPM
- safety control systems 34.4% 34.5% 0.1% Improved from 21% in 2H14
- control valves 32.2% 31.6% -0.6%
- railway signaling systems 48.4% 43.8% -4.6% Delay of orders delivery lead to operating deleverage
- train electrified equipment 29.4% 27.2% -2.2% Decline in GPM mainly due to intensed industry competition
- engineering & maintenance 74.1% 74.4% 0.3%
- distribution of equipment 16.8% 21.7% 4.9%
Operating cash inflow 28 174 524.2%
Investment cash outflow (44) (51) 16.3%
Net cash/(debt) position (1,095) (912)
Cash 503 593 17.9%
Short term debt 435 342 -21.3%
Long term debt 1,163 1,162 0.0%
Page 4 of 17
The worst should be over, initiate with BUY
We expect a 5% decline in FY14E revenue mainly because CAG decided to scale down
the equipment distribution segment. And we forecast a moderate 8% revenue CAGR
during FY14-16E, largely driven by 1) the pickup in sales of railway signaling system
and 2) increasing market share in the fragmented control valves market.
We also expect GPM to be in an uptrend after CAG gradually completes the low margin
or even loss making orders in safety control system segment. Besides, CAG is putting
more focus on costs control, we believe there is still room for further improvement in
efficiency after a series of M&A in 2010-12.
While provision for bad debt would remain the major uncertainty factor for CAG earnings
performance (most of the overdue receivables came from the railway constructors such
as CRG (390 hk)), situation could improve as the PRC government is considering
various options to solve the liquidity problem of CRC (one potential solution is to open
railway construction to private capital). We project an annual new provision of
RMB20mn during FY14-16E.
We believe the worst for CAG should be over, and the potential increase of CRC’s
spending in 2H14 would provide a stronger boost to CAG in FY15E. Initiate with BUY,
target price at HK$2.05, which translate to 10X FY15E PER, a 10% discount to the
average of H share railway system and equipment suppliers.
Exhibit 2: Peers comparison
Source: Bloomberg, CIRL
Ticker Mkt cap Price
(HKD mn) (HKD) FY13A FY14E FY15E FY13A FY14E FY15E
CSR CORP LTD-H 1766 HK
Equity93,600 7.10 18.8 14.6 12.7 2.1 1.9 1.7
CHINA CNR CORP-H 6199 HK
Equity81,748 6.87 13.6 11.7 10.4 1.5 1.3 1.2
ZHUZHOU CSR-H 3898 HK
equity34,441 29.30 17.5 16.1 13.9 3.0 2.6 2.3
CHINA ITS HOLDIN 1900 HK
equity2,117 1.28 11.3 11.3 8.8 0.6 0.6 0.6
CHINA CITY RAILW 1522 HK
equity2,280 1.77 23.9 N/A N/A 3.5 N/A N/A
Average 17.0 13.4 11.4 2.1 1.6 1.5
XIANGTAN ELEC-A 600416 CH
Equity9,776 16.07 159.2 47.3 31.4 3.6 3.6 3.4
JINXI AXLE -A 600495 CH
Equity10,132 15.09 56.3 42.0 31.5 2.7 3.1 2.8
BAOTOU BEIFANG-A 600967 CH
Equity17,872 21.72 54.4 35.8 26.3 6.4 5.2 4.4
Average 89.9 41.7 29.7 4.2 3.9 3.5
HONEYWELL INTL HON US
Equity576,102 736.19 19.0 17.1 15.4 4.3 3.8 3.3
EMERSON ELEC CO EMR US
Equity349,637 500.97 23.2 17.4 15.7 4.3 4.2 3.9
GENERAL ELECTRIC GE US
Equity2,018,773 201.19 20.3 15.5 14.2 2.0 2.1 1.9
WOODWARD INC WWD US
Equity26,561 405.57 24.5 21.3 19.5 3.1 2.6 2.3
ROCKWELL AUTOMAT ROK US
Equity124,998 906.61 21.5 19.1 17.1 6.3 6.1 5.3
SIEMENS AG-REG SIE GR
Equity869,977 987.52 19.1 14.7 13.1 2.8 2.7 2.5
ABB LTD-REG ABBN VX
Equity414,794 179.20 19.1 17.8 15.4 2.8 2.7 2.5
NARI TECHNOLOG-A 600406 CH
Equity51,134 21.05 25.3 20.5 16.4 6.6 5.2 4.1
GUODIAN NANJ-A 600268 CH
Equity5,821 9.16 726.2 28.3 N/A 1.9 N/A N/A
Average 99.8 19.1 15.9 3.8 3.7 3.2
CAG 569 HK 1,632 1.59 17.7 9.9 7.8 0.7 0.7 0.6
International Automation system or equipment
P/E(x) P/B(x)
Railway system or equipment - H shares
Railway system or equipment - A shares
Page 5 of 17
Exhibit 3: Key assumptions
Source: CAG, CIRL
Income statement
Year to Dec (RMB mn) FY12A FY13A FY14E FY15E FY16E
Total revenue 2,211 2,309 2,188 2,360 2,550
- Peterochemical - safety control systems 920 892 850 875 919
- Peterochemical - control valves 343 583 604 695 778
- Railway - signaling systems 317 349 309 371 408
- Railway - electrified equipment 222 130 162 179 193
- Engineering & maintenance 156 169 180 191 202
- Distribution of Equipment 252 186 83 50 50
Gross profit 865 828 823 910 983
SG&A expenses (474) (487) (445) (476) (515)
R&D expenses (74) (96) (88) (94) (102)
Profit from associates and JVs (13) (2) (1) (2) (2)
Other income / expenses 61 74 62 62 62
Operating profit 366 317 351 399 425
Net provision of bad debt (72) (60) (20) (20) (20)
Finance costs (131) (135) (130) (125) (120)
Profit before tax 163 122 201 254 285
Tax expenses (34) (37) (55) (68) (76)
Minority interest (44) (11) (15) (19) (21)
Net profit 85 74 131 167 188
Ratio
Year to Dec FY12A FY13A FY14E FY15E FY16E
GPM 39.1% 35.9% 37.6% 38.6% 38.5%
- Peterochemical - safety control systems 40.9% 29.1% 35.2% 37.5% 38.0%
- Peterochemical - control valves 35.8% 33.8% 32.3% 32.0% 32.0%
- Railway - signaling systems 41.8% 47.7% 45.3% 46.0% 45.0%
- Railway - electrified equipment 40.5% 32.3% 26.1% 25.0% 25.0%
- Engineering & maintenance 68.6% 70.4% 70.8% 70.0% 70.0%
- Distribution of Equipment 15.5% 24.3% 22.7% 22.0% 22.0%
Cost ratio
SG&A sales 21.4% 21.1% 20.3% 20.2% 20.2%
Effective tax rate 21.1% 30.5% 27.5% 27.0% 26.8%
Page 6 of 17
Exhibit 4: Financial statement
Source: Bloomberg, CIRL
Income statement Cash flow
Year to Dec (RMB mn) FY12A FY13A FY14E FY15E FY16E Year to Dec (RMB mn) FY12A FY13A FY14E FY15E FY16E
Revenue 2,211 2,309 2,188 2,360 2,550 Pre-tax profit 163 122 201 254 285
Gross profit (reported) 865 828 823 910 983 Taxes paid (34) (37) (55) (68) (76)
EBITDA 381 320 364 417 448 Depreciation 64 74 73 78 82
Depreciation & Amortization (64) (74) (73) (78) (82) Associates 13 2 1 2 2
EBIT 317 246 290 339 366 CFO bef. WC change 205 161 221 265 293
Net interest income (exp.) (127) (132) (130) (125) (120) Change in working cap (422) 21 (10) (115) (134)
Provision for bad debt (72) (60) (20) (20) (20) Cashflow from operation (217) 182 211 150 159
Associates (13) (2) (1) (2) (2) CAPEX (192) (126) (100) (80) (80)
Exceptionals/others 58 71 62 62 62 Free cash flow (409) 56 111 70 79
Profit before tax 163 122 201 254 285 Dividends (21) (10) 0 0 0
Tax expenses (34) (37) (55) (68) (76) Balance sheet adj. (108) 30 9 2 2
Minority interest (44) (11) (15) (19) (21) Shares issued 0 0 0 0 0
Net profit 85 74 131 167 188 Others 0 0 0 0 0
Dividends (21) 0 0 0 0 Net cash flow (538) 76 120 72 81
Net cash (debt) start (484) (1,023) (947) (827) (755)
Balance sheet Net cash (debt) at year-end (1,023) (947) (827) (755) (674)
Year to Dec (RMB mn) FY12A FY13A FY14E FY15E FY16E
Cash & equiv 561 598 753 859 976 Ratios
Trade receivables 1,700 1,825 1,794 1,900 2,028 Year to Dec FY12A FY13A FY14E FY15E FY16E
Other receivables 185 203 241 260 281 Growth rate (%)
Inventories 857 751 724 769 831 Revenue 11.6 4.4 (5.2) 7.9 8.0
Other current assets 121 77 78 78 78 EBITDA (3.0) (16.0) 13.8 14.6 7.3
Fixed assets 559 595 618 624 627 EBIT (9.9) (22.6) 18.2 16.9 7.7
Goodwill and Intangible assets 536 596 596 592 588 Net profit (56.8) (13.0) 78.5 27.1 12.7
Investment, associates etc 157 134 126 124 122 Fully diluted EPS (56.8) (13.0) 78.5 27.1 12.7
Total assets 4,677 4,778 4,929 5,205 5,529 Margins (%)
Gross margin (reported) 39.1 35.9 37.6 38.6 38.5
Account payables 480 425 410 435 470 EBITDA 17.2 13.8 16.6 17.7 17.5
Other payables 380 492 478 508 549 EBIT 14.3 10.6 13.3 14.4 14.3
Short-term debt 400 397 420 453 490 Net margin 3.8 3.2 6.0 7.1 7.4
Other current liabs 38 30 27 27 27 Other ratios
Long-term debts 1,183 1,147 1,160 1,160 1,160 ROE (%) 4.1 3.4 5.7 6.7 7.0
Other long-term liabs 120 122 125 127 129 ROA (%) 1.8 1.5 2.7 3.2 3.4
Total liabilities 2,601 2,614 2,619 2,710 2,825 Net gearing (%) 49.3 43.7 35.8 30.2 24.9
Interest coverage (x) 2.5 1.9 2.2 2.7 3.0
Share capital 10 10 10 10 10 Receivables days 280.7 288.5 299.3 293.8 290.2
Reserves 1,751 1,813 1,944 2,111 2,299 Payables days 130.3 104.9 109.5 109.5 109.5
Shareholders' equity 1,760 1,823 1,954 2,121 2,309 Inventory days 232.5 185.1 193.5 193.5 193.5
Minorities 315 341 356 374 395 Effective tax rate (%) 19.6 30.0 27.3 26.8 26.6
Total equity 2,075 2,164 2,310 2,495 2,704
Net cash (debt) (1,023) (947) (827) (755) (674)
Page 7 of 17
System and equipment provider in petrochemical and railway industries
China Automation Group (CAG) is primarily engaged in petrochemical and railway
industries. It offers two major product categories for each sector, including 1) safety
control systems and 2) control valves for petrochemical industry, as well as 3) signaling
systems and 4) auxiliary power supply and traction systems for railway industry. As a
supplement to its core system and equipment businesses, CAG also provides 5)
engineering & maintenance and 6) equipment distribution services to their customers.
Exhibit 5: 4 core product segments of CAG
Source: CAG
Exhibit 6: Revenue and gross profit breakdown in FY13
Source: CAG, CIRL
Page 8 of 17
Expanded into new product segments through series of M&A
CAG entered the safety control system industry in 1999, and expanded to other product
segments through a series of M&A and cooperation during 2008-2012, including
acquisition of Beijing Jiaoda Microunion, Zhongjing, Nanjing Huashi, Wuzhong
Instrument as well as establishment of JV with ABB. This strategy allows CAG to
venture into other markets with high technological and licensing barriers, in our view.
Exhibit 7: CAG has expanded into various new business segments through M&A
Source: CAG
Strong position in all 4 core segments
CAG has established a strong position in PRC for all of its 4 core segments, which
included 1) ~70% market share in the safety control system market of petrochemical
and coal chemical industry, 2) the 4th largest and the only domestic top 10 player in the
PRC control valve market, 3) one of the four certified Railway Interlocking System (“RIS”)
suppliers, and 4) one of the five qualified electrified equipment suppliers recognized by
the China Railway Corporation (“CRC”).
Exhibit 8: CAG has established strong position in its core segments
Source: CAG
Time Period Company Key products Nature % of interestsConsideration /
Initial Investment
2008 Beijing Jiaoda Microunion Railway signaling system Acquisition 76.7% RMB303.5mn
2009 ABB Microunion Railway tractor converter and
auxiliary converter
Joint Venture 50.0% USD3mn
2010 Zhongjing Engineering and
construction design of
petrochemical plants
Acquisition 70.0% RMB25mn
2011 Nanjing Huashi Railway traction and auxiliary
power supply system
Acquisition 51.0% RMB160mn
2010-12 Wuzhong Instrument Control Valves Acquisition 100.0% RMB343.8mn
Page 9 of 17
Railway segment: improving orders, metro market a new opportunities
CAG is involved in the railway industry mainly through its 76.7% and 51.0% subsidiaries,
Beijing Jiaoda Microunion (“BJM”) and Nanjing Huashi (“Huashi”), which provided
signaling systems as well as electrified equipment (including auxiliary power supply and
traction systems) respectively.
~30% market share in RIS, a key component of the railway signaling system
BJM is one of the four certified Railway Interlocking System (“RIS”) suppliers granted by
CRC, with a market share of ~30%. RIS is a key component of the railway signaling
system, which is installed in the stations and locks the railroad switch when a train
passes by, in order to ensure that the trains will go through the right railroad and prevent
collision between trains.
While RIS remained the major contributor, BJM has also developed other signaling
system products to enrich its coverage in the railway signaling system segment over the
past few years. For instance, Centralized Traffic Control System (“CTC”) is another core
products of BJM, which is a centralized system that monitors and manages overall train
traffic and railway station operation. Products of BJM could be applied in both railway
and metro.
Exhibit 9: Railway signaling system products of BJM
Source: CAG
Products Functions
RIS (Railway Interlocking
System)
Used in railroad switch in railway stations to direct trains along the right
tracks and prevent collision, so as to protect life and property safety
CTC (Centralized Traffic
Control System)
Long-distance integrated monitoring towards signaling systems and train
operation and carry out centralized controls over train traffic in all stations
TCC (Train Control Centre
System)
An integrated control panel mainly used in highspeed railway and utilized
with operation monitoring, data sharing and emergency control
function. Capable of the real-time monitoring and management of data
like railway network video, train operation, daily traffic as well as disaster
information
ATS (Automated Train
Supervision)
Compulsory automated traffic control system of the Metro business,
which manage facilities and traffic data, monitor and control traffic and
assist traffic control technician to manage operation of the train
ATP (Automatic Train
Protection)
ATP system is installed in the train to provide train speed monitor and
speeding protection. The ATP system transmits signals affecting the
safety operation of the train from the ground onto the train and hence
allowing the train to be aware of it safety speed and attains the speed
supervision and management of the train
ATO (Automatic Train
Operation System)
The ATO system allows an unattended train to navigate, stop, open and
close train door automatically. ATO system can work on instructions from
signaling systems like ATP and accelerates or decelerates accordingly.
The use of ATO system can reduce the time required for acceleration
and deceleration and shorten s train interval
Page 10 of 17
One of the five qualified electrified equipment suppliers recognized by the CRC
On the other hand, Huashi is one of the five qualified electrified equipment suppliers
recognized by the CRC. Major products of Huashi included auxiliary power supply
system (which is used to supply power to door, lighting, air-conditioning, etc) and
traction system (assembled in a power car to convert power between direct current and
alternating current). Its major revenue contributor, DC600V traction system, which
mainly applied in passenger cars, has a market share of >30%, according to
management.
Exhibit 10: Products of Huashi
Traction system Electical control cabinet
Source: Huashi
Improving orders from railway segment, stronger demand is expected in 2015
After years of weakness in railway segment since the Wenzhou train accident in mid
2011, management see sign of recovery in 1H14. For instance, after the restructuring of
China Railway Corporation (“CRC”) from Ministry of Railways (MOR) in 1H13, CRC
resumed train tendering in 3Q13, hence train electrified equipment sales of CAG
rebounded from RMB64-72mn in the last 3 half-year periods to RMB82mn in 1H14.
For railway signaling system products, management expressed that orders was
improving with ~RMB250mn new orders in 1H14, which is higher than the actual sales
figure of all 4 half-year periods during FY12-13, Besides, CRC announced a spending
target of >RMB800bn in April 2014, revised up from the original target of RMB630bn,
representing a ~20% yoy growth (RMB660bn in 2013). As CAG’s railway signaling
products are generally installed at the later stage of a new railway development, it
generally received orders 1-1.5 years after the railway construction kickoff. Hence if
CRC accelerates investment to achieve its spending target in 2H14, it would bring a
more significant boost to CAG in 2015.
Page 11 of 17
Exhibit 11: Railway fixed-asset investment is expected to have ~20% yoy growth in 2014
Source: CRC
Entering the metro traction system market
Besides, Huashi won its first two traction system contracts for subway projects in 2013,
namely Guangzhou Subway Line 9 and Nanjing Subway Line 1, which would contribute
~RMB100mn revenue to Huashi in FY14-16E. While a lower GPM is expected for these
contracts as CAG is still in the learning curve, management views it as a significant
breakthrough into the huge metro market. For instance, there would be tender for ~20
metro lines nationwide in 2014.
Page 12 of 17
Control valve: the growth engine in petrochemical segment
Stepped into control valve market leverage on the success in safety control system products
CAG gradually acquired 100% interests in Wuzhong Instrument (Wuzhong) during
2010-12. Prior to the acquisition, Wuzhong was a SOE which primarily engaged in
manufacturing control valves with 50 years of history. Control valve is widely applied in
petrochemical, coal-chemical, chemical, power and metallurgy industries to adjust the
flow, pressure, temperature or liquid level during the production process in response to
the control signal from automation systems.
Exhibit 12: Control valves products of CAG
Source: Wuzhong
4th
largest control valve manufacturer in the PRC
Wuzhong enjoys the synergy with CAG’s original safety control system business, as 1)
CAG has established strong reputation among petrochemical and coal-chemical
companies, which are the major target customers of Wuzhong, and 2) both safety
control system and control valve are a critical part to ensure safe production, hence it ’s
convenient for CAG to do cross selling.
After acquired by CAG, Wuzhong achieved decent results in recent years, which turned
profitable in 2012 and achieved 28% organic sales growth in 2013 (70% in financial
statement as only 8 months of Wuzhong’s sales was consolidated in 2012), way above
the industrial growth rate of ~8-10%. In 2013, Wuzhong was the 4th largest and the only
domestic top 10 player in the PRC control valve market with ~4% share according to
“Control Valve Magazine”.
Page 13 of 17
Exhibit 13: Top 10 control valve manufacturers in the PRC market in 2013
Source: “Control Valve Magazine”
Huge room for further growth in a fragmented market
We believe Wuzhong still has huge potential going forward, since annual demand of
control valve in PRC is huge (~RMB15bn), and it is less cyclical in comparison to safety
control system products as it consists more replacement demand (the life cycle of
control valve and safety system are 3-5 years and 8-10 years respectively).
Opportunity from high end market in medium growth
In medium term, CAG could also increase Wuzhong’s exposure in high end control
valve market. Currently, domestic control valve manufacturers are mainly involved in the
low to mid end segment while the high end market is dominated by the foreign brands.
Wuzhong has gradually developed various high end products including axial flow valves,
tank bottom valves, high-temperature high-pressure ball valves, etc. We expect
Wuzhong could gain market share in high end market gradually due to its cost
advantage over oversea players, which would enhance its margin.
Rank Company Country Market Share
1 Fisher USA 12%
2 Koso Japan 6%
3 Pentair valves & controls USA 5%
4 Wuzhong Instrument PRC 4%
5 Flowserve USA 4%
6 Spirax Sarco UK 3%
7 Metso Finland 3%
8 Rotork UK 3%
9 CCI USA 3%
10 Burkert Germany 3%
Page 14 of 17
Safety control system: GPM to improve from FY13 level
Leading safety control system provider with ~70% share in PRC
CAG enjoys ~70% share in safety control system market in PRC’s petrochemical and
coal chemical industry. CAG’s dominant position could be attributed to 1) its ability in
providing a total solution to customers and 2) exclusive cooperation agreement with
leading hardware supplier.
Providing a wide range of safety control system products
The chemical plants generally need a range of system products to ensure safe and
smooth production. Through years of R&D, CAG has developed various system
software to meet the needs of different customers. Besides, by acquiring 70% interests
of Zhongjing in 2010, CAG could offer engineering design service to the chemical plants,
making CAG a total safety control system solution provider.
Exhibit 14: CAG offers a wide range of safety control system products to its customers
Source: CAG
Exclusive cooperation agreement with Triconex
CAG has acted as the sole supplier of Triconex’s products in the PRC since 2006, and
the two companies have extended the cooperation agreement for 3 more years in 2014.
Triconex is a global leader of safety control system products with >20% market share.
With key hardware supplied by renovated global company, CAG becomes a reliable
partner to the petrochemical and coal chemical plant operators including included
Sinopec, PetroChina, Shenghua etc.
Products Functions
ITCC (Integrated Turbine &
Compressor Control System)
Used in compressor machinery, flow, anti-surge control etc. Other
functions include logic control, turbine speed regulation and emergency
shutdown
iMEC (Intelligent Machinery
Expert Control Systems)
With mature ITCC technology, iMEC system is able to continuously
collect, monitor and manage various forms of compressor data, lower the
rate of faults and reduce equipment maintenance quantity and operation
cost
iSOM (Intelligent Safety
Operation Management)
ISOM system is aimed at completely resolving such problems as
generator set alarm and shutdown messages for our clients, sharing our
experiences in generator set control parameter, parameter adjustment,
generator set operation parameter monitoring, etc so as for our clients to
better understand the generator set, find out faults and clear them in the
set
ITCC-OTS (Integrated Turbine
& Compressor Controls -
Operation Training System)
OTS is an ITCC-based simulation system for operation training that CAG
have developed on the basis of the summary of over a decade of
successful experiences in applying ITCC. OTS may enhance the safety
and reliability of equipment operation to a maximum extent through the
improvement of operators' skill and contingency ability
ESD (Emergency Shutdown
Devices )
A control system which will override and interfere the production systems
when it is at risk, assuring the safety during the production as well as
preventing it from signficant harm
FGS (Fire and Gas Systems) A significant component of the system which ensures safety production.
It covers gas (flammable gas and toxic gas) detection and fire alarm
systems
Page 15 of 17
Exhibit 15: CAG utilizes key hardware supplied by Triconex for its safety control systems
Source: Triconex
Putting more focus on profitability, GPM to improve from FY13 level
CAG’s safety control system segment achieved 27% sales CAGR during FY07-12. In
addition to the organic demand growth from petrochemical and coal chemical industry,
CAG also expanded their footprint into overseas as well as other industries including oil
pipe network and electricity plants. However, some of these new customers brought a
negative effect to profitability.
For instance, two orders on hand from Singapore recorded ~RMB25mn and ~RMB8mn
gross loss in FY13 and 1H14 respectively, according to management. As a result, GPM
of CAG’s safety control system segment dropped significantly from 41-45% in FY09-12
to 29%/35% in FY13/1H14 (excluding the Singapore orders, GPM would be 35% and
39% in FY13 and 1H14, according to our estimation).
CAG started terminating the Singapore unit and reduced exposure to non-core and
lower margin segment such as products related to oil and gas industry since FY13.
Management would continue to put a higher priority on profitability to achieve ~38%
GPM in short term. We expect sales to decline by 5% in FY14E, while gross profit to
increase by 15% with an improvement in GPM.
Page 16 of 17
Risk factors
Risk on the collection of outstanding receivables
CAG has a huge amount of receivables and some of it is overdue (RMB431mn of
receivables is over 1 year as of 30 Jun 14). While we see CAG is putting a lot of effort to
collect back the outstanding receivables, and it now has a stricter cash flow
management for new orders, it is still possible for CAG to make further provision for the
receivables on hand in the future.
Economic risk
The performance of CAG business, especially the safety control system segment, is
correlated with the PRC economy environment. A sluggish PRC economy performance
would affect the profitability of CAG.
Execution risk
CAG is expanding into various business segment through M&A in recent years, and it
also entered into overseas market, where the management have less experience. Such
expansion could potentially harm the profitability of CAG.
Competition risk
Some business segments of CAG, including control valve and train electrified
equipment, are facing a relatively more competitive market environment. CAG may lose
market share or need to accept a lower GPM if competition further intensify.
Financing risk
CAG is having a relatively high gearing level. While it has no major expansion or
acquisition plan at this moment, it could still face financing difficulty for working capital
requirement, and it may also consider equity financing in the future.
Page 17 of 17
Rating Policy
Rating Definition
Stock Rating Buy Outperform HSI by 15%
Neutral Between -15% ~ 15% of the HSI
Sell Underperform HSI by -15%
Sector Rating Accumulate Outperform HSI by 10%
Neutral Between -10% ~ 10% of the HSI
Reduce Underperform HSI by -10%
Analysts List
Antony Cheng Research Director (852) 2235 7127 [email protected]
Hayman Chiu Senior Research Analyst (852) 2235 7677 [email protected]
Kenneth Li Senior Research Analyst (852) 2235 7619 [email protected]
Lewis Pang Senior Research Analyst (852) 2235 7847 [email protected]
Susanna Chui Research Analyst (852) 2235 7131 [email protected]
Analyst Certification
I, Lewis Pang hereby certify that all of the views expressed in this report accurately reflect my personal views about the
subject company or companies and its or their securities. I also certify that no part of my compensation was / were, is /
are or will be directly or indirectly, related to the specific recommendations or views expressed in this report / note.
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