Page 1 of 14

Company Report

7 Jul 2014

Lewis Pang

lewis.pang@cinda.com.hk

(852) 2235 7847

Trading data

52-Week Range (HK$)

3 Mth Avg Daily Vol (m)

No of Shares (m)

Market Cap (HK$m)

Major Shareholders (%)

Auditors

Result Due

1.24/2.03

1.2

1,026

1,498

Mr. Xuan Ruiguo

(44.65%)

Deloltte

1H14: Aug Company description

Listed in 2007, China Automation Group (CAG) is

primarily engaged in petrochemical and railway

industries. It offers two major product categories

for each sector, including 1) safety control

systems and 2) control valves for petrochemical

industry, as well as 3) signaling systems and 4)

auxiliary power supply and traction systems for

railway industry.

Price chart

Looking for the end of the tunnel Rating NOT RATED

Current price

HK$1.46

Improving orders from railway, expect a stronger boost in 2015

After years of weakness in railway segment since the Wenzhou train

accident in mid 2011, management expressed that both orders and

deliveries are improving in recent months. In April 2014, China

Railway Corporation (“CRC”) announced a spending target of

>RMB800bn, which is revised up from the original target of

RMB630bn, representing a ~20% yoy growth (RMB660bn in 2013).

As CAG’s products are generally installed at the later stage, we

expect it to enjoy a more significant boost in 2015.

Entering the metro traction system market

CAG won its first two traction system contracts for subway projects

in 2013, namely Guangzhou Subway Line 9 and Nanjing Subway

Line 1, which would contribute ~RMB100mn revenue to CAG in

FY14-16E. While a lower GPM is expected for these contracts as

CAG is still in the learning curve, management views it as a

significant breakthrough into the huge metro market. For instance,

there would be tender for ~20 metro lines nationwide in 2014.

Safety control system: putting more focus on margin

GPM of CAG’s safety control system segment dropped significantly

from 41-45% in FY09-12 to 29% in FY13, which was the results of

those low margin orders (mainly from overseas or other industries

including oil pipe network) taken in previous years. For instance, two

Singapore orders recorded ~RMB80mn revenue and RMB25mn

gross loss in FY13. CAG is now putting more focus on profitability,

we expect a rebound of GPM with a flattish sales in FY14E.

Control valve: the growth engine in petrochemical segment

In 2012, CAG completed the acquisition of Wuzhong Instrument, the

4th largest and the only domestic top 10 player in the PRC control

valve market. Sales of Wuzhong remained strong in 1H14, and we

expect control valve would be CAG’s growth engine in petrochemical

segment due to 1) its established reputation among petrochemical

and coal-chemical companies, and 2) cost advantage over oversea

players in high end control valve market.

Moderate growth in FY14E, expect a brighter future ahead

We expect 8% revenue and 6% operating profit growth in FY14E.

Provision for bad debt would remain the major uncertainty factor for

its earnings. Assuming RMB50mn provision, CAG is trading at ~13X

FY14E PER. we believe there would be a stronger boost for its

railway business in FY15E, and we like its strategy to expand into

control valves market. We suggest investors to keep an eye on the

company, potential catalyst included the further acceleration of PRC

railway spending and improvement in the liquidity of CRC.

RMB million FY10A FY11A FY12A FY13A FY14E

Revenue 1,595 1,981 2,211 2,309 2,532

Operating profit 394 416 366 317 337

Net Profit 286 196 85 74 91

EPS (RMB) 0.281 0.194 0.082 0.071 0.089

P/E ( x) 4.2 6.0 14.2 16.3 13.1

Sources: Bloomberg, CIRL estimates

China Automation Group | 569.HK

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System and equipment provider in petrochemical and railway industries

China Automation Group (CAG) is primarily engaged in petrochemical and railway

industries. It offers two major product categories for each sector, including 1) safety

control systems and 2) control valves for petrochemical industry, as well as 3) signaling

systems and 4) auxiliary power supply and traction systems for railway industry. As a

supplement to its core system and equipment businesses, CAG also provides 5)

engineering & maintenance and 6) equipment distribution services to their customers.

Exhibit 1: 4 core product segments of CAG

Source: CAG

Exhibit 2: Revenue and gross profit breakdown in FY13

Source: CAG, CIRL

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Expanded into new product segments through series of M&A

CAG entered the safety control system industry in 1999, and expanded to other product

segments through a series of M&A and cooperation during 2008-2012, including

acquisition of Beijing Jiaoda Microunion, Zhongjing, Nanjing Huashi, Wuzhong

Instrument as well as establishment of JV with ABB. This strategy allows CAG to

venture into other markets with high technological and licensing barriers, in our view.

Exhibit 3: CAG has expanded into various new business segments through M&A

Source: CAG

Strong position in all 4 core segments

CAG has established a strong position in PRC for all of its 4 core segments, which

included 1) ~70% market share in the safety control system market of petrochemical

and coal chemical industry, 2) the 4th largest and the only domestic top 10 player in the

PRC control valve market, 3) one of the four certified Railway Interlocking System (“RIS”)

suppliers, and 4) one of the five qualified electrified equipment suppliers recognized by

the China Railway Corporation (“CRC”).

Exhibit 4: CAG has established strong position in its core segments

Source: CAG

Time Period Company Key products Nature % of interestsConsideration /

Initial Investment

2008 Beijing Jiaoda Microunion Railway signaling system Acquisition 76.7% RMB303.5mn

2009 ABB Microunion Railway tractor converter and

auxiliary converter

Joint Venture 50.0% USD3mn

2010 Zhongjing Engineering and

construction design of

petrochemical plants

Acquisition 70.0% RMB25mn

2011 Nanjing Huashi Railway traction and auxiliary

power supply system

Acquisition 51.0% RMB160mn

2010-12 Wuzhong Instrument Control Valves Acquisition 100.0% RMB343.8mn

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Railway segment: improving orders, metro market a new opportunities

CAG is involved in the railway industry mainly through its 76.7% and 51.0% subsidiaries,

Beijing Jiaoda Microunion (“BJM”) and Nanjing Huashi (“Huashi”), which provided

signaling systems as well as electrified equipment (including auxiliary power supply and

traction systems) respectively.

~30% market share in RIS, a key component of the railway signaling system

BJM is one of the four certified Railway Interlocking System (“RIS”) suppliers granted by

CRC, with a market share of ~30%. RIS is a key component of the railway signaling

system, which is installed in the stations and locks the railroad switch when a train

passes by, in order to ensure that the trains will go through the right railroad and prevent

collision between trains.

While RIS remained the major contributor, BJM has also developed other signaling

system products to enrich its coverage in the railway signaling system segment over the

past few years. For instance, Centralized Traffic Control System (“CTC”) is another core

products of BJM, which is a centralized system that monitors and manages overall train

traffic and railway station operation. Products of BJM could be applied in both railway

and metro.

Exhibit 5: Railway signaling system products of BJM

Source: CAG

Products Functions

RIS (Railway Interlocking

System)

Used in railroad switch in railway stations to direct trains along the right

tracks and prevent collision, so as to protect life and property safety

CTC (Centralized Traffic

Control System)

Long-distance integrated monitoring towards signaling systems and train

operation and carry out centralized controls over train traffic in all stations

TCC (Train Control Centre

System)

An integrated control panel mainly used in highspeed railway and utilized

with operation monitoring, data sharing and emergency control

function. Capable of the real-time monitoring and management of data

like railway network video, train operation, daily traffic as well as disaster

information

ATS (Automated Train

Supervision)

Compulsory automated traffic control system of the Metro business,

which manage facilities and traffic data, monitor and control traffic and

assist traffic control technician to manage operation of the train

ATP (Automatic Train

Protection)

ATP system is installed in the train to provide train speed monitor and

speeding protection. The ATP system transmits signals affecting the

safety operation of the train from the ground onto the train and hence

allowing the train to be aware of it safety speed and attains the speed

supervision and management of the train

ATO (Automatic Train

Operation System)

The ATO system allows an unattended train to navigate, stop, open and

close train door automatically. ATO system can work on instructions from

signaling systems like ATP and accelerates or decelerates accordingly.

The use of ATO system can reduce the time required for acceleration

and deceleration and shorten s train interval

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One of the five qualified electrified equipment suppliers recognized by the CRC

On the other hand, Huashi is one of the five qualified electrified equipment suppliers

recognized by the CRC. Major products of Huashi included auxiliary power supply

system (which is used to supply power to door, lighting, air-conditioning, etc) and

traction system (assembled in a power car to convert power between direct current and

alternating current). Its major revenue contributor, DC600V traction system, which

mainly applied in passenger cars, has a market share of >30%, according to

management.

Huashi also provides other supplementary products such as electrical control cabinets.

In FY13, GPM of Huashi is particularly low (32% versus 36-40% in FY11-12) as a higher

proportion of sales came from these lower margin supplementary products. Based on

current orders on hand, this situation is expected to continue at least until 2H14E.

Exhibit 6: Products of Huashi

Traction system Electical control cabinet

Source: Huashi

Improving orders from railway segment, stronger demand is expected in 2015

After years of weakness in railway segment since the Wenzhou train accident in mid

2011, management expressed that both orders and deliveries are improving in recent

months. In April 2014, CRC announced a spending target of >RMB800bn, which is

revised up from the original target of RMB630bn, representing a ~20% yoy growth

(RMB660bn in 2013). As CAG’s products are generally installed at the later stage of a

new railway development, it generally received orders 1-1.5 years after the railway

construction kickoff, hence we expect the re-acceleration of PRC railway spending

would bring a more significant boost to CAG in 2015.

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Exhibit 7: Railway fixed-asset investment is expected to have ~20% yoy growth in 2014

Source: CRC

Entering the metro traction system market

Besides, Huashi won its first two traction system contracts for subway projects in 2013,

namely Guangzhou Subway Line 9 and Nanjing Subway Line 1, which would contribute

~RMB100mn revenue to Huashi in FY14-16E. While a lower GPM is expected for these

contracts as CAG is still in the learning curve, management views it as a significant

breakthrough into the huge metro market. For instance, there would be tender for ~20

metro lines nationwide in 2014.

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Safety control system: putting more focus on margin

Leading safety control system provider with ~70% share in PRC

CAG enjoys ~70% share in safety control system market in PRC’s petrochemical and

coal chemical industry. CAG’s dominant position could be attributed to 1) its ability in

providing a total solution to customers and 2) exclusive cooperation agreement with

leading hardware supplier.

Providing a wide range of safety control system products

The chemical plants generally need a range of system products to ensure safe and

smooth production. Through years of R&D, CAG has developed various system

software to meet the needs of different customers. Besides, by acquiring 70% interests

of Zhongjing in 2010, CAG could offer engineering design service to the chemical plants,

making CAG a total safety control system solution provider.

Exhibit 8: CAG offers a wide range of safety control system products to its customers

Source: CAG

Exclusive cooperation agreement with Triconex

CAG has acted as the sole supplier of Triconex’s products in the PRC since 2006, and

the two companies have extended the cooperation agreement for 3 more years in 2014.

Triconex is a global leader of safety control system products with >20% market share.

With key hardware supplied by renovated global company, CAG becomes a reliable

partner to the petrochemical and coal chemical plant operators including included

Sinopec, PetroChina, Shenghua etc.

Products Functions

ITCC (Integrated Turbine &

Compressor Control System)

Used in compressor machinery, flow, anti-surge control etc. Other

functions include logic control, turbine speed regulation and emergency

shutdown

iMEC (Intelligent Machinery

Expert Control Systems)

With mature ITCC technology, iMEC system is able to continuously

collect, monitor and manage various forms of compressor data, lower the

rate of faults and reduce equipment maintenance quantity and operation

cost

iSOM (Intelligent Safety

Operation Management)

ISOM system is aimed at completely resolving such problems as

generator set alarm and shutdown messages for our clients, sharing our

experiences in generator set control parameter, parameter adjustment,

generator set operation parameter monitoring, etc so as for our clients to

better understand the generator set, find out faults and clear them in the

set

ITCC-OTS (Integrated Turbine

& Compressor Controls -

Operation Training System)

OTS is an ITCC-based simulation system for operation training that CAG

have developed on the basis of the summary of over a decade of

successful experiences in applying ITCC. OTS may enhance the safety

and reliability of equipment operation to a maximum extent through the

improvement of operators' skill and contingency ability

ESD (Emergency Shutdown

Devices )

A control system which will override and interfere the production systems

when it is at risk, assuring the safety during the production as well as

preventing it from signficant harm

FGS (Fire and Gas Systems) A significant component of the system which ensures safety production.

It covers gas (flammable gas and toxic gas) detection and fire alarm

systems

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Exhibit 9: CAG utilizes key hardware supplied by Triconex for its safety control systems

Source: Triconex

Putting more focus on profitability

CAG’s safety control system segment achieved 27% sales CAGR during FY07-12. In

addition to the organic demand growth from petrochemical and coal chemical industry,

CAG also expanded their footprint into overseas as well as other industries including oil

pipe network and electricity plants. However, some of these new customers brought a

negative effect to profitability. For instance, two orders on hand from Singapore

recorded ~RMB80mn revenue and RMB25mn gross loss in FY13, according to

management. As a result, GPM of CAG’s safety control system segment dropped

significantly from 41-45% in FY09-12 to 29% in FY13 (GPM would be 35% if we

excluded the two Singapore orders).

CAG became more selective and avoided taking orders of which they are less familiar

with in FY13. Along with the sluggish economy and tight liquidity environment, safety

control system sales declined 3% yoy in FY13. We expect a flattish sales with a rebound

in GPM for this segment in FY14E, however, the margin would still be lower than

historical average as CAG is expected to incur another ~RMB10mn gross loss from the

unfinished Singapore orders mentioned above.

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Control valve: the growth engine in petrochemical segment

Stepped into control valve market leverage on the success in safety control system products

CAG gradually acquired 100% interests in Wuzhong Instrument (Wuzhong) during

2010-12. Prior to the acquisition, Wuzhong was a SOE which primarily engaged in

manufacturing control valves with 50 years of history. Control valve is widely applied in

petrochemical, coal-chemical, chemical, power and metallurgy industries to adjust the

flow, pressure, temperature or liquid level during the production process in response to

the control signal from automation systems.

Exhibit 10: Control valves products of CAG

Source: Wuzhong

4th

largest control valve manufacturer in the PRC

Wuzhong enjoys the synergy with CAG’s original safety control system business, as 1)

CAG has established strong reputation among petrochemical and coal-chemical

companies, which are the major target customers of Wuzhong, and 2) both safety

control system and control valve are a critical part to ensure safe production, hence it’s

convenient for CAG to do cross selling.

After acquired by CAG, Wuzhong achieved decent results in recent years, which turned

profitable in 2012 and achieved 28% organic sales growth in 2013 (70% in financial

statement as only 8 months of Wuzhong’s sales was consolidated in 2012), way above

the industrial growth rate of ~8-10%. In 2013, Wuzhong was the 4th largest and the only

domestic top 10 player in the PRC control valve market with ~4% share according to

“Control Valve Magazine”.

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Exhibit 11: Top 10 control valve manufacturers in the PRC market in 2013

Source: “Control Valve Magazine”

Huge room for further growth in a fragmented market

We believe Wuzhong still has huge potential going forward, since annual demand of

control valve in PRC is huge (~RMB15bn), and it is less cyclical in comparison to safety

control system products as it consists more replacement demand (the life cycle of

control valve and safety system are 3-5 years and 8-10 years respectively). Wuzhong is

taking a more aggressive pricing strategy to obtain more market share, we expect a

3-4ppt decline in GPM with ~20% sales growth in FY14E.

Opportunity from high end market in medium growth

In medium term, CAG could also increase Wuzhong’s exposure in high end control

valve market. Currently, domestic control valve manufacturers are mainly involved in the

low to mid end segment while the high end market is dominated by the foreign brands.

Wuzhong has gradually developed various high end products including axial flow valves,

tank bottom valves, high-temperature high-pressure ball valves, etc. We expect

Wuzhong could gain market share in high end market gradually due to its cost

advantage over oversea players, which would enhance its margin.

Rank Company Country Market Share

1 Fisher USA 12%

2 Koso Japan 6%

3 Pentair valves & controls USA 5%

4 Wuzhong Instrument PRC 4%

5 Flowserve USA 4%

6 Spirax Sarco UK 3%

7 Metso Finland 3%

8 Rotork UK 3%

9 CCI USA 3%

10 Burkert Germany 3%

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Moderate growth in FY14E, expect a brighter future ahead

Moderate revenue and operating profit growth in FY14E

After achieved a historical high profit of RMB286mn in FY10, CAG has entered a down

trend during FY11-13, which could be attributed to 1) sluggish orders from railway sector,

2) increased in financing costs after a series of M&A (from RMB25mn in FY10 to

RMB123-135mn in FY11-13), and 3) sizable net provision for bad debt (RMB72mn and

RMB60mn in FY12 and FY13 respectively).

For FY14E, we expect a moderate revenue growth of 8%, driven by the railway related

products as well as control valves. GPM would likely to be under pressure, as 1) CAG is

taking a competitive pricing strategy for control valves products, 2) GPM of railway

signaling system would be normalized (48% in FY13 versus 41-42% in FY11-12) and 3)

higher contribution from low margin products in the traction and auxiliary power supply

system segment. CAG targets to maintain a stable operating margin by tightly SG&A

costs and R&D costs. All in all, we expect a 6% yoy growth in operating profit.

Bad debt for provision remained the major uncertainty

Provision for bad debt would remain the major uncertainty factor for CAG earnings

performance. According to management, currently there are >RMB100mn account

receivables which is overdue for more than 2 years. Most of these receivables came

from the railway constructors such as CRG (390 hk). However, we believe the PRC

government is considering various options to solve the liquidity problem of CRC, and

one potential solution is to open railway construction to private capital.

Medium term likely to improve while short term earnings still insecure

CAG is trading at ~13X FY14E PER if we assume RMB50mn net bad debt provision.

While the short term earnings outlook of CAG is still relatively insecure, we believe its

railway business would soon be seeing the end of the tunnel, and the increasing railway

spending of CRC should provide a stronger boost to CAG in FY15E. We also like its

strategy to expand into control valves market after it has established a dominant

position in the petrochemical safety control system market. We suggest investors to

keep an eye on the company, potential catalyst included the further acceleration of PRC

railway spending and improvement in the liquidity of CRC.

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Exhibit 12: Financial statement

Source: Bloomberg, CIRL

Year to Dec (RMB mn) FY10A FY11A FY12A FY13A FY14E

Total revenue 1,595 1,981 2,211 2,309 2,532

- Peterochemical - safety control systems 610 796 920 892 900

- Peterochemical - control valves 0 0 343 583 700

- Railway - railway signaling systems 589 476 317 349 402

- Railway - traction and auxiliary power supply system 0 108 222 130 162

- Engineering & maintenance 124 151 156 169 178

- Distribution of Equipment 272 450 252 186 190

Gross profit 664 758 865 828 875

- Peterochemical - safety control systems 278 338 376 260 293

- Peterochemical - control valves 0 0 123 197 212

- Railway - railway signaling systems 256 195 133 167 167

- Railway - traction and auxiliary power supply system 0 39 90 42 45

- Engineering & maintenance 84 104 107 119 123

- Distribution of Equipment 46 82 39 45 35

SG&A expenses (263) (371) (474) (487) (519)

R&D expenses (34) (34) (74) (96) (81)

Profit from associates and JVs (3) (7) (13) (2) (3)

Other income / expenses 30 71 61 74 65

Operating profit 394 416 366 317 337

Net provision of bad debt (6) 4 (72) (60) (50)

Finance costs (25) (123) (131) (135) (130)

Profit before tax 362 297 163 122 157

Tax expenses (42) (53) (34) (37) (42)

Minority interest (35) (48) (44) (11) (23)

Net profit 286 196 85 74 91

Page 13 of 14

Exhibit 13: Peers comparison

Source: Bloomberg, CIRL

Ticker Mkt cap Price

(HKD mn) (HKD) FY12A FY13A FY14E FY12A FY13A FY14E

CSR CORP LTD-H 1766 HK

Equity80,036 6.25 17.0 16.5 13.1 2.1 1.8 1.7

CHINA CNR CORP-H 6199 HK

Equity71,431 5.53 13.2 11.0 9.8 1.3 1.2 1.1

ZHUZHOU CSR-H 3898 HK

equity28,858 24.55 17.7 14.6 13.8 3.5 2.5 2.2

CHINA ITS HOLDIN 1900 HK

equity2,667 1.62 16.5 14.3 12.3 0.9 0.8 0.7

CHINA CITY RAILW 1522 HK

equity2,317 1.80 14.0 24.3 12.0 4.2 3.6 N/A

XIANGTAN ELEC-A 600416 CH

Equity7,343 12.07 N/A 119.6 29.8 2.9 2.7 N/A

JINXI AXLE -A 600495 CH

Equity7,284 17.36 35.3 40.5 24.1 2.6 1.9 2.2

BAOTOU BEIFANG-A 600967 CH

Equity14,143 17.19 51.2 43.0 23.6 5.8 5.0 4.4

Average 23.5 35.5 17.3 2.9 2.4 2.1

HONEYWELL INTL HON US

Equity575,866 735.34 25.3 19.0 17.1 5.7 4.3 3.8

EMERSON ELEC CO EMR US

Equity366,407 522.13 25.1 24.2 17.9 4.7 4.5 4.3

GENERAL ELECTRIC GE US

Equity2,087,510 208.17 20.8 21.0 15.9 2.3 2.1 2.1

WOODWARD INC WWD US

Equity25,812 389.30 24.3 23.6 21.5 3.4 3.0 2.6

ROCKWELL AUTOMAT ROK US

Equity135,402 978.00 24.2 23.2 20.3 9.5 6.8 6.5

SIEMENS AG-REG SIE GR

Equity906,399 1,028.82 21.5 19.9 14.8 2.9 2.9 2.7

ABB LTD-REG ABBN VX

Equity412,410 178.16 19.5 19.0 16.8 3.1 2.8 2.7

NARI TECHNOLOG-A 600406 CH

Equity43,086 17.74 26.7 21.3 17.2 6.5 5.5 4.3

GUODIAN NANJ-A 600268 CH

Equity3,928 6.18 21.9 490.1 19.1 1.3 1.3 N/A

Average 23.3 73.5 17.8 4.4 3.7 3.6

CAG 569 HK 1,498 1.46 14.2 16.3 13.1 0.7 0.6 0.6

International Automation system or equipment

P/E(x) P/B(x)

Railway system or equipment

Page 14 of 14

Rating Policy

Rating Definition

Stock Rating Buy Outperform HSI by 15%

Neutral Between -15% ~ 15% of the HSI

Sell Underperform HSI by -15%

Sector Rating Accumulate Outperform HSI by 10%

Neutral Between -10% ~ 10% of the HSI

Reduce Underperform HSI by -10%

Analysts List

Antony Cheng Research Director (852) 2235 7127 antony.cheng@cinda.com.hk

Hayman Chiu Senior Research Analyst (852) 2235 7677 hayman.chiu@cinda.com.hk

Kenneth Li Senior Research Analyst (852) 2235 7619 kenneth.li@cinda.com.hk

Lewis Pang Senior Research Analyst (852) 2235 7847 lewis.pang@cinda.com.hk

Susanna Chui Research Analyst (852) 2235 7131 susanna.chui@cinda.com.hk

Analyst Certification

I, Lewis Pang hereby certify that all of the views expressed in this report accurately reflect my personal views about the

subject company or companies and its or their securities. I also certify that no part of my compensation was / were, is /

are or will be directly or indirectly, related to the specific recommendations or views expressed in this report / note.

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