China Gets Winning Formula For Silk Road Railway

| About: China Railway (CRWOY)

Summary

China agreed to help Iran building a railway which will form part of China's High Speed Silk Road Railway.

China has a winning SRR formula: dual-Usage bullet train technology and irresistible co-operation terms.

When SRR completed, freight train from China can reach Western Europe in 3.5 days.

Countries along SRR like to join, attracted by freight train passage fees and opportunity to participate China-Europe value chain.

I assign "overweight" position for China Railway which is closely linked with SRR, waiting for buying signals.

China recently agreed to help building Iran's first high speed railway, which will form part of China-Europe Silk Road Railway (SRR). Other similar deals along the SRR are expected to sign soon as Beijing has found a winning formula to build this backbone infrastructure of its ambitious One Belt, One Road (OBOR) program. China Railway Group (OTCPK:CRWOY), China's largest railway infrastructure contractor is expected to win most contracts and its share prices will be benefited.

Chinese president Xi Jinping visited Tehran late January and witnessed the signing of the agreement of building the 900km high speed railway connecting Tehran and the Northeastern city of Mashhad, Iran's second largest city.

Winning Formula Part One: Dual-Usage Bullet Train Technology

As the planned Iranian railway lies very close to a China-Iran railway proposed by China Railway, it will form part of the proposed railway. The proposal submitted to Tehran last November has two parts: a) the railway starts in Urumqi, capital of China's western-most Xinjiang region, and ends in Tehran some 3,200 km away (Fig 1); and b) China will initially build only a single rail line with standard gauge using high speed rail technology. Passenger trains will run at up to 300 km per hour while the freight trains will run at a top-of-the-class 120 km/h.

Fig. 1: The proposed China-Iran railway. Source: China Daily

The alignment of the China-Iran railway is important, as it fits into the Central Corridor option of SRR. The Central Corridor passes south of the Caspian Sea and linking several Central and Western Asian countries before entering Southeastern Europe (Fig. 2).

Fig.2: The alignment of proposed China-Europe railway via Tehran. Source: China Daily

The countries along the Central Corridor lack the financial and technological capacity of building high speed railways. China thus has huge strategic leverage on the railway design, construction and management. In contrast, the northern corridor passes only through Mongolia, Kazakhstan and Russia, placing Beijing in a less favorable negotiation position.

The choice of the Central Corridor also helps China to tap the natural resources of the countries along the railway and explore the newly-opened Iranian market of 78 million people.

The China-Iran Railway proposal shows Beijing's technological flexibilities and forms one of the two parts of China's winning formula for the SRR. Building a single rail line (and almost certainly leaving space for future second line) means lower initial investments and shorter building time. Passenger and freight trains share the same rail line corresponds better to the actuality that demands for freight transport (especially between Europe and China) far exceeds that of regional passenger transits. Also, one single standard gauge means freight trains between Europe and China can run at full speed all the way.

Winning Formula Part Two: Irresistible Co-operation Terms

The second part of the winning formula is the irresistible terms offered to Iran and other countries along the railway. China's agreement with Indonesia reached last October will set as the standard -- Beijing, through its China Development Bank, agreed to provide three quarters of the 60 billion yuan project finance with very low interest rates, without requiring loan guarantee from Jakarta. The remaining finance comes from the joint venture which builds and operates the high speed rail. The four local partners of the joint venture, all state-owned enterprises, contribute mainly lands, for building stations and depots etc. The joint venture's financing mainly comes from the Chinese partner China Railway.

China is expected to apply this two-part formula to the SRR as it is the backbone of President Xi's darling OBOR project which he hopes to become China's new economic growth engine. The SRR will also benefit China economically at least as much as other countries along the railway.

China has long sought to send goods to Europe via railways. Even facing the inconvenience of different railway gauges, it takes about two weeks to complete the journey while sea freights take 30 to 40 days. Connecting its most important trading partner Europe with efficient railways also alleviate Beijing's fear of its sea trades blockaded by the United States and Japan.

In January 2008, the first China-Europe freight train service--between Beijing and Hamburg was inaugurated. The 6,210 miles (about 10,000 km) journey run via the Trans-Mongolian Railway, the Trans-Siberian Railway to Moscow, and then to Germany via rail links in Belarus and Poland. Total transit time was 15 days. The average speed is 28 km/h, as the railways of Post-Soviet Russia and Central Asian states are in poor condition and the trains had to first change from China's standard 1,435 mm gauge tracks to Soviet-gauge 1,520 mm tracks, and then back to the standard gauge used in Europe. The goods also had to be customs cleared several times.

China Freight Trains Will Reach Europe In 3.5 Days

Not content with the present slow traffic, building an all-standard gauge high speed Eurasian railway is a top priority for China. When the high speed all-standard-gauge SRR (with a journey of about 10,000 km from Urumqi to Calais, France, ref. Fig 2) is completed and operated under a coordinated management, secure and electronically sealed freight trains of speed 120km/h will be customs-cleared just once and run between China and Europe non-stop. The journey in theory will take just 3.5 days, not too slow compared with around 12 hours taken by air freight but 80% cheaper! If Iran and other countries along the SRR become processing or transshipment centers for industrial and farm product, their goods can reach Europe or China in one or two days.

In fact, joining the value chain between China and Europe -- the two largest economies of the world (Fig.3) -- is a major attraction for all countries along the SRR. In addition, the irresistible partnership terms to be offered by Beijing means the countries can get the railway practically free of charge and are guaranteed with steady income from freight train transit fees. The railway will also become national focal points for industrial and agricultural developments as well as the starting points of domestic high speed railways.

Fig.3 Europe and China GDP (in PPP) Were Biggest in World in 2014. Source: Business Insider

China Railway Target Price Climbs back Above Market Price

Being China's largest contractor for foreign railway infrastructure projects and who proposed the China-Iran Railway, China Railway's share price should be directly linked to China's railway export performance. But the company's share price has neither benefited from the signing of Indonesian and Iranian accords, nor burdened by the suspension of works in the Indonesian high speed railway project earlier this year.

The share prices have indeed been dictated by macro factors: first rocketed in the first half of 2015 fueled by China's stock market boom, but later pressured by the subsequent market bust as well as a continued sharp slowdown of Chinese economic growth.

With China's stock market and economic performance finally stabilized as we entered 2016, China Railway's share prices have bottomed out. The average target prices have also rebounded back to above the market prices. For example, according to Reuters, the average target price now for China Railway in Shanghai is 9.68 yuan, while recent market price was just above 8 yuan, with "Hold" consensus (Fig 4):

Similarly, the average Hong Kong target price gathered by MarketWatch is HK$7.25, also above the actual price of around HK$5.7, with "Overweight" consensus.

Conclusion: Waiting For "BUY" Signals

The formal name of OBOR is "The Silk Road Economic Belt and the 21st-Century Maritime Silk Road". From the name alone, you can tell that an economic belt is much more important than a road. As China has already earmarked a $40 billion New Silk Road Fund, its determination for building the SRR -- the backbone of the economic belt is beyond doubt.

Several high speed railways are already in different stages of construction in Turkey, Bulgaria, Serbia and Hungary carried out by China Railway and her compatriot peers. These railways will one day link up and form the western section of SRR, between Iran and Germany, China's largest trading partner in Europe. Future high speed railways in Former Soviet republics between China and Iran are either under negotiation or preparation.

Yet, a string of terrorist attacks are battering Turkey's tourism industry and makes the country the weakest link in the economic belt project. In addition, China's economy is expected to struggle to meet the lower end of the 6.5-7% growth rate target range this year set by Beijing. In view of these two downside risks, I assign China Railway an "Overweight" rating.

Nevertheless, China Railway's share price still has a much larger upside potential in view of Beijing's determination to build the SRR as well as exporting its bullet train system; all the company needs are the following "Buy" signals:

  • Renewed market rumors of it merging with compatriot competitor China Railway Construction (OTCPK:CWYCY) to avoid mutual competition and improve competitiveness abroad. China's two largest railway rolling stock manufacturers CSR and CNR have already been merged under Beijing's order to form the world's largest company in the field CRRC ((CRRRF, CN:601766; HK:1766)) for the same reason.
  • News of further high speed railway contract signed between China and the Central Asian and eastern European countries along the SRR.
  • News of the Shanghai Cooperation Organization, which groups China, Russia and four Central Asian countries, meeting to discuss cooperation on the SRR project. This will indicate the countries are willing to take multilateral approach on building and managing the future railway.
  • News of China Railway winning the lucrative Malaysia-Singapore high speed railway project tender.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

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