A standstill in Chinese rail industry. Our analysis of Midas’s recent results and discussions with management suggest that the Chinese rail industry may be at a virtual standstill following the dismissal of the former head of the Ministry of Railways (MOR) and recent accident investigations.
3Q11 a prelude for next few quarters. As expected, Midas posted a poor set of 3Q11 results following a profit warning. While the market focused on its orderbook, we had warned that the latter is often a fluid process in China, especially when customers are powerful state-owned enterprises. Net profit was down both QoQ and YoY by more than 50% despite capacity expansion. Another worrying aspect is that working capital ballooned to Rmb119m this quarter alone.
Too much uncertainty for now. What essentially happened in 3Q11 was that Midas’s main customer CNR took slower delivery as it, in turn, delivered less trains to MOR due to the various recalls and investigations. Similarly, this was also the cause behind 32.5% metro-manufacturing associate NPRT turning in a loss this quarter.
Don’t read too much into recent MOR measures. With no new orders in sight following the dismissal of the former MOR head, the slowdown in upstream delivery will invariably affect suppliers like Midas, at least over the next three quarters. Much has been made out of recent measures to help MOR raise funds, but this may not necessarily be for new orders.
Downgrade to Sell. We expect things will get worse before it gets better and downgrade our stock recommendation to Sell. We cut our FY11-12 estimates by about 30% to account for slower execution on orderbook (estimated Rmb840m). Our target price of $0.30 is pegged at 8x FY12F, where we expect support from our more draconian SOTP-based worst-case value.
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