Industrials

David Fickling is a Bloomberg Gadfly columnist covering commodities, as well as industrial and consumer companies. He has been a reporter for Bloomberg News, Dow Jones, the Wall Street Journal, the Financial Times and the Guardian.

China's 2014 merger of its high-speed rail giants CSR and CNR wasn't just about creating a business with the scale to take on the world's biggest trainmakers.

It was also an attempt to demonstrate that mergers in the country's outsized state industrial sector could forge smarter champions. Technological expertise would be a bigger selling point than government ties, especially for international customers. Beijing would lose some parasitic, state-dependent businesses and gain powerful new technology exporters in return.

The early signs from this process were good. CRRC, the merged trainmaker, instantly became the world's second-biggest industrial company after General Electric. Its shares in Shanghai rose by the daily limit on its first day of trading in June 2015. 

There's since been a steady progress south. Shares of competitors have generally done pretty well over the past year: General Electric is up 27 percent, Siemens has risen 20 percent, and Bombardier surged 51 percent as its troubled C Series passenger jet program started to win orders.

France's Alstom has performed more poorly with a 15 percent decline, but CRRC has been the laggard of the pack, falling 20 percent over the past year and 55 percent from its debut last June. Even in valuation terms, it's now the least-loved among its peers:

Hero to Zero
Blended forward 12-month price-earnings valuations of major trainmakers
Source: Bloomberg
Note: Bombardier line ends in February because consensus forward earnings estimates dropped to losses, making short-term forward p/e valuations meaningless.

The company's second-quarter results, published Monday night, help illustrate why. Net income trailed estimates and the stock fell as much as 7.3 percent in Tuesday trading, the biggest intraday decline in seven months.

To be sure, some of the promised export contracts appear to be showing up. Newly signed industrial orders overseas in the first half of the year came to 15 billion yuan ($2.3 billion), more than double the total a year earlier and on a par with rivals. Alstom recorded 889 million euros ($1 billion) of orders in the June quarter, when the train-related businesses of Siemens, General Electric and Bombardier chalked up 1.1 billion euros, $700 million, and $2.1 billion respectively.

Turn to the touted benefits of the merger, however, and there's less to boast about. Cost of sales, a measure that ought to be benefiting from the synergies mentioned six times in CRRC's earnings release, fell just 0.9 percent in the first half from a year earlier, a change that even the company acknowledged was "not significant." Elsewhere, selling and distribution costs dropped but administrative expenses rose for a net increase of 261 million yuan, suggesting CRRC isn't any leaner than when it was created.

"The company is encountering unprecedented challenges and continuous operational pressure," management wrote in their announcement. "The operating trends are not optimistic."

Add to that the fact that shareholder capital is being dedicated to some questionable purposes -- such as the 4.5 billion yuan spent in January on buying a 13 percent stake in China United Insurance and a mooted involvement in Elon Musk's Hyperloop supersonic vacuum train -- and you have to wonder if CRRC is looking quite such a model business after all.

Coming Up Short
CRRC has failed to match analysts' target prices even as they've cut their forecasts over the past year
Source: Bloomberg

The downside surprise in Monday's earnings follows a similar disappointment in first-quarter results and 2015's second-quarter results 12 months earlier, according to data compiled by Bloomberg. Since the shares started trading last year, CRRC has consistently fallen short of analysts' target prices.

This champion is looking distinctly weakened. If China's other state-brokered mergers can't produce better results, Beijing will need to go back to the drawing board.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
David Fickling in Sydney at dfickling@bloomberg.net

To contact the editor responsible for this story:
Matthew Brooker at mbrooker1@bloomberg.net