Double whammy for China's rail transport sector. Outlook for Midas Holdings (Midas) has grown increasingly murky in recent times. The highspeed train collision in China in Jul this year was followed by yet another collision last week, this time between two metro trains in Shanghai. This could result in a delay in the awarding of metro contracts by the various municipal governments as China has ordered a nation-wide safety investigation. Media reports have also claimed that China has postponed construction of 80% of its railway projects. While a delay was expected, this amount does seem substantial, in our opinion, and would affect the earnings visibility of upstream railway parts suppliers such as Midas. The rail transport industry contributed 73.5% of Midas' total revenue in 1H11. However, it is not known yet whether the Chinese government would be reducing its target for railway investments for its 12th Five-Year Plan. We believe that a scale-back in the magnitude of its investments seems plausible, as the financial condition of China's Ministry of Railways (MOR) is showing signs of deteriorating. Media reports have stated that MOR had delayed payments amounting RMB60b to two railway contractors, while its debt outstanding has also increased (RMB2.09t at end 2QCY11 versus RMB1.98t at end 1QCY11).
Patience is a virtue. While these series of events have created a nearterm overhang on China's rail transport sector, we believe that the longterm prospects are still positive. This is driven by the fundamental need to fulfil China's rising transportation needs and continued economic development. As China intends to develop more mega cities, in areas such as Chengdu and Wuhan, we believe that this rising urbanisation augurs well for the sector due to the expected increase in demand for high-speed and metro trains. Meanwhile, we believe that Midas would increase its focus on the power and industrial machinery industries in the near term to mitigate the impact of a delay in rail transport contract wins.
Maintain BUY on valuation grounds. We are keeping our estimates for now until there is greater clarity on the Chinese government's railway policies. Nevertheless, given the macroeconomic uncertainties and significant de-rating of China's railway sector related stocks, we see the need to lower our valuation peg on Midas to 8x blended FY11/FY12F EPS (previously 16x), in-line with the average forward PER of its railway parts manufacturing peers. Consequently, our fair value estimate is reduced from S$0.805 to S$0.435. Notwithstanding this, we are maintaining our BUY rating on valuation grounds as its share price has already tumbled 64.0% YTD and the stock is currently trading at FY11F P/NTA of 0.7x.
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