Back on the rails

China's major infrastructure players have been on a roll this year with these once-ignored stocks back in demand among investors who are attracted by their relatively high dividends and cheap valuations.

Investment banks including Citibank and Morgan Stanley have raised their bets on the infrastructure sector which has been buoyed by pump-priming and post-Covid stimulus to the tune of trillions of yuan, despite fears of a global recession.

Infrastructure spending in China is expected to rise by almost a fifth to more than 12 trillion yuan (HK$13.65 trillion) this year with two-thirds of its provinces planning major projects such as transport infrastructure, energy generation and industrial parks, according to Bloomberg.

And three leading infrastructure stocks in Hong Kong's market - China Railway Group or CREC (0390), China Railway Construction or CRCC (1186) and China Communications Construction Company or CCCC (1800) - appear to be benefiting from the recovery theme as their stocks have risen around 30 percent this year, significantly outperforming the benchmark Hang Seng Index in 2023.

Infrastructure spending has accelerated in the first quarter - typically the off-season for construction - and investment in this sector are projected expand by 10 percent in 2023, following 9 percent growth in the first two months of the year.

Fitch Ratings says infrastructure investment growth is likely to be steady in 2023, with a continued strong performance in the first half and some moderation in the second half, due to front-loaded investments and an expected recovery post-reopening.

Infrastructure investment remains an important counter-cyclical tool for China to bolster economic growth in 2023, it says, especially during the initial period after the lifting of all Covid curbs, when property investment and consumption remain weak.

Citic Securities, meanwhile, expects reforms initiated by state-owned enterprises will boost valuations and stimulate their stocks to perform well throughout the year.

China Railway

With the highest market capitalization among the three heavyweights, CREC is Citibank's and Morgan Stanley's top choice in the mainland infrastructure sector, given its better profitability and solid balance sheet.

Citibank says CREC is seeing its business expand from traditional infrastructure such as railroads into green infrastructure such as hydropower and waste treatment, and this will enhance its profitability.

It raised its earnings forecast in 2023 and 2024 by 4 percent and 6 percent respectively to reflect last year's results, as its first-quarter net profit grew 3.8 percent year-on-year to 7.87 billion yuan (HK$8.89 billion).

The stock is currently undervalued, of which its projected price-to-book ratio is only 0.3 times, yet it has a dividend yield of over 5 percent. This, says Citibank, makes it the best target to capture the potential waves of revaluation.

Meanwhile, state-owned enterprise reforms, infrastructure construction in the mainland, as well as overseas expansion as part of China's Belt and Road initiative will catalyze revaluation in the sector in the coming months, says Morgan Stanley.

The bank expects overseas orders from infrastructure firms to exceed targets this year, as the market has regained interest in the Belt and Road projects, which may stimulate exports of mainland engineering and construction.

Earlier this month, CREC breached the HK$6 mark which was last seen in June 2019, though it tumbled to HK$5.43 last Friday amid a broader market decline. Citi has given a buy rating and raised the target price on CREC to HK$7.6, while Morgan Stanley suggests a target price of HK$7.5, up 27 percent from its last report and rated as overweight.

China Railway Construction

Ranked by Morgan Stanley as another favorable pick after CREC, CRCC has bounced back from its 2022 low of HK$3.7, hitting a 2023 high of HK$7.46 on May 8. Last Friday, it closed at HK$6.36 , up 30 percent for the year.

State investment in high-speed railways has laid a strong foundation for the future growth of the stock.

China last year invested 710.9 billion yuan in railroad fixed assets and investments in the first four months of 2023 rose 6.3 percent yearly to 167.4 billion yuan with the mainland pump-priming the economy, according to China State Railway Group, the national railway operator.

This year, more than 3,000 kilometers of new railway lines are expected to be put into operation, including 2,500 km of high-speed railways.

CRCC has benefited from these investment as its business has been resilient even during the Covid-19 pandemic which halted many infrastructure projects.

Its new contracts were worth 3.25 trillion yuan last year, an increase of 15 percent year-on-year, while new contracts for the first quarter of 2023 totaled 539.63 billion yuan, up 16 percent from last year and around 16 percent of its annual target of 3.31 trillion yuan.

Its operating profit margin has been steady at 3.4 percent, but a relatively low valuation of 3.5 in this year's price-to-earnings ratio forecast makes the stock a tempting choice when considering its price.

As Citibank expects CRCC's order growth to reach high single digits this year, it has raised the target price by 10 percent to HK$7.7 but adds that it prefers CREC due to the US sanctions on CRCC. Morgan Stanley has upped the target price by 33 percent from HK$6 to HK$8.

China ComMunications Construction

Among the three stocks, CCCC recorded highest profit growth in the first quarter, up 9.6 percent to 5.58 billion yuan, compared to a moderate 3 percent growth for both CRCC and CREC. Besides, the company has maintained the dividend payout rate at around 20 percent, the highest among the three stocks.

The value of its new contracts for the first quarter rose 6.3 percent to 457.8 billion yuan, reaching 30 percent of its annual target.

Also, recent news about its restructure could act as a catalyst for its stock price.

In March, the State Council's supervising unit of all state-owned enterprises gave the green light to a proposed spin-off of three subsidiaries specialized in highway construction and its plan to list under a reorganization with Shanghai-listed Gansu Qilianshan Cement Group, a subsidiary of China National Building Material (3323). On completion of the restructure, CCCC will become the controlling shareholder of Qilianshan with a 53.88 percent stake.

CCCC hit three-year high earlier this month at HK$5.48, and was last traded at HK$4.93. Citibank has raised its target price by 36 percent to HK$5.2 with a neutral rating, while Morgan Stanley has lowered its rating from overweight to equal-weight, expecting the stock's performance to be in line with the average return of the other stocks.