Rail Opening to China’s Inland Benefits Daqin: Freight Markets

China plans to spend at least $1.3 trillion over the next five years to ease transport and freight bottlenecks in the country, creating a windfall for companies from Daqin Railway Co. to Anhui Expressway Co.

Rising wages and land costs in the coastal provinces that underpinned China’s industrial development for three decades are forcing manufacturers including Ford Motor Co., Pfizer Inc. and Foxconn Technology Group to move production inland to cut costs. That’s strained China’s ability to transport goods within the country, prompting a spending program the size of the Swiss economy in the past two years on roads, railways and airports.

“A huge part of China hasn’t been part of the global economy,” said Brian Jackson, an emerging-markets strategist at Royal Bank of Canada in Hong Kong who previously worked at the Federal Reserve and Bank of England. “As that changes, it’s going to have a similar impact to what you saw with coastal China joining the world economy.”

Development of inland provinces such as Shanxi and Anhui that hold more than half the country’s population is driving an expansion of rail capacity that may help shares of Datong-based Daqin Railway rise 86 percent to 16.03 yuan ($2.44), according to Morgan Stanley. Hefei-based toll-road operator Anhui Expressway may rise 44 percent to HK$9 ($1.15) as inland growth is boosted by companies moving from the east coast, says Macquarie Capital Securities.

Inland Development

China spent $569 billion on fixed-asset investment in railways and roads over the past two years. That may help more than double China’s share of world exports to 23 percent in the next decade as companies move inland, according to Hong Kong- based China International Capital Corp. economist Zhang Zhiwei.

Over the next five years China will spend as much as 3.5 trillion yuan on railway construction, 750 billion yuan on rail rolling stock, 3.5 trillion to 4 trillion yuan on highways, 300 billion to 350 billion yuan on airports, and 900 billion yuan on ports, according to Macquarie.

The nation’s 2 trillion yuan in spending on a high-speed rail network will give it almost as much track by next year as the entire rest of the world, even before the 16,000-kilometer network is completed in 2020. More than 7,000 kilometers of track have already been laid so far and another 6,000 kilometers are scheduled to open by 2012.

Freeing Capacity

The new tracks are taking passenger traffic, freeing space for cargo to be carried on existing lines. That removes “a big logistical barrier to moving goods around” that will boost the retail industry and help drive new clusters of industrial development in inland cities, said Arthur Kroeber, managing director of Beijing-based Dragonomics, an economic advisory firm whose clients include Fortune 500 companies and hedge funds.

Freight transported between the southern city of Guangzhou and Wuhan in central China has more than doubled since December 2009, when a high-speed service began between the cities and consequently increased capacity for cargo, according to the Ministry of Railways.

Shenzhen-based Guangshen Railway Co.’s freight business benefited from the Guangzhou-Wuhan link, and will be further aided when the line is extended from Guangzhou to Shenzhen this year, according to Hong Kong-based Morgan Stanley analyst Edward Xu. He expects the company’s stock price to rise 29 percent to HK$4.08 per share.

Goldman Says Buy

Goldman Sachs Group Inc. reiterated its buy recommendation on the stock of Daqin Railway on Feb. 11, citing its price-to- earnings ratio at 9.5 times 2011 earnings and a potential increase in freight rates. Daqin operates China’s biggest coal transport line, linking Datong in Shanxi province to Qinhuangdao on the Bohai Sea east of Beijing.

China’s fixed-asset investment in highways climbed 23 percent last year to almost 1.3 trillion yuan. Construction also began on 25 new airports across the country. The nation’s biggest container terminal operators, Cosco Pacific Ltd. and China Merchants Holdings International Co., are investing in ports along the 6,300 kilometer-long (3,915 mile-long) Yangtze River, which reaches Tibet, to help alleviate congestion.

As companies move inland so toll road operators such as Anhui Expressway and Sichuan Expressway Co. stand to benefit, said Anderson Chow, an analyst with Macquarie in Hong Kong.

“Anhui Expressway is like a conduit for the central part of China linking up with Shanghai,” said Chow. He expects the company’s earnings per share to rise 22 percent a year on a compounded basis through 2012. Sichuan Expressway will see earnings per share rise 24 percent annually over the same period, Chow estimated.

Lure of Money

The surge in investment isn’t without risks: the flow of funds increases the threat of corruption and loans that go bad.

Railway Minister Liu Zhijun, who has overseen plans for the nation’s high-speed rail network, was removed from his post in the Communist Party and is under investigation for “severe” disciplinary violations, state news agency Xinhua reported Feb. 12. Shares of companies including CSR Corp., the nation’s biggest train maker, and China CNR Corp., the second largest, tumbled.

The “blind pursuit” of high-speed rail is “highly likely to develop into a debt crisis,” wrote Zhao Jian, a professor of economics at Beijing Jiaotong University, in a commentary in the China Daily newspaper last year.

Investments in transport links are making inland China more attractive for manufacturers including Taiwan’s Foxconn, which is expanding in Chongqing, and Intel Corp., which said last year it would lay off 2,000 workers at a Shanghai plant and move some production to Chengdu in the western province of Sichuan.

Going West

Pfizer, the world’s largest drug maker, said it will set up a research and development center in Wuhan in central China, while Ford’s joint venture in the country, Changan Ford Mazda Automobile Co., announced it will invest $500 million in Chongqing.

Improved transport links will also boost urbanization in second-and third-tier cities in China and lead to the construction of more affordable suburban housing, making companies like plastic pipe maker China Liansu Group Holdings Ltd. one of the best ways to invest in the inland boom, said Andy Mantel, managing director of Hong Kong-based Pacific Sun Investment Management Ltd.’s Mantou Fund.

“The build-out of affordable housing will be a key theme for the next five years and gigantic amounts of funds will be earmarked for this,” said Mantel, who bought Liansu Group stock in November.

- Kevin Hamlin. Editors: Adam Majendie, Chris Anstey

To contact the Bloomberg News staff on this story: Kevin Hamlin in Beijing on khamlin@bloomberg.net

To contact the editor responsible for this story: Paul Panckhurst at panckhurst@bloomberg.net

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