Industrials have been my favorite sector for the fourth quarter of this year; my latest recommendati...
Faster than a speeding bullet train: Three high-speed rail plays to put on your watch list
03/24/2010 6:17 pm EST
Why not all three? Because the rising stars of the new generation of high-speed rail companies are Chinese and Korean and it’s hard to buy into these companies now. The European and Canadian companies that once dominated this space are easy to buy into but are facing a huge challenge from the “upstarts.”
And U.S. companies are barely even players in this space, unfortunately.
More on why that’s unfortunate for anyone who wants this economic recovery to produce enough new jobs to reduce U.S. unemployment below 6% in a moment. First, let’s look at those potential high-speed stock picks.
The world is looking at growth in high-speed rail that’s faster than a speeding locomotive. In 2005 a study by Germany’s SCI Verkehr projected that the length of the world’s high-speed rail networks would double over the next ten years. According to the study by 2015 high-speed rail networks would total 14,400 kilometers (roughly 8,600 miles), up from 6,300 kilometers in 2004.
Boy, was that study wrong. In the next three years China alone will put 9,200 kilometers of new high-speed lines into operation, according to the Chinese Ministry of Railways. That’s more than the total global increase projected in 2005 from that year to 2015.
The world’s countries are playing leapfrog in high-speed rail. Spain plans that its network of high-speed trains will pass that of Japan in length this year. India and China are both planning to pass Spain within a few years.
And the equipment that will speed along these tracks? Built by the traditional developed economy pioneers—Canada’s Bombardier (BDRXF.PK), France’s Alstom (AOMFF.PK), Japan’s Kawasaki Heavy Industries (KWHIY.PK) and Germany’s Siemens (SI)—plus a raft of new competitors from Korea and China that are quickly taking share in the market.
Last week marked what I’d call the changing of the guard in the industry. On March 16 Siemens decided that it would bid for a $7 billion Mecca to Medina high-speed line in Saudi Arabia as part of a Chinese consortium instead of bidding on its own or as part of the competing Saudi-led consortium.
The move makes sense to me. Chinese companies are on a roll in this market. Chinese companies have closed enough of the gap on quality and technology with their developed-economy rivals so that their aggressive pricing and financing packages now often determine the winner in any bidding. By adding its technology, especially in signaling, to the Chinese consortium Siemens stands a good chance of being on the winning team. True the company won’t have the entire contract to itself but a piece of the pie is better than none.
Who are the new players that I especially like?
From China: China South Locomotive & Rolling Stock. From Korea: Hyundai Rotem.
The rise of these companies shouldn’t be especially surprising. They’ve and the governments that sponsored them—and in many cases still own a majority of their shares--followed a tried and true strategy for building a new industry. The strategy isn’t a secret. France, Germany, Japan, Korea, and other countries have it to create their own industries in everything from high-speed trains to telecommunications equipment to ship building to steel making to autos to solar cells.
The strategy starts with creating massive domestic demand and protecting that domestic market, using anything from technology standards to taxes to trade rules, from foreign competition. That lets young domestic companies build up economies of scale so they can compete on price and, eventually, product quality and technology. (At the same time, the size of the domestic market attracts overseas companies who, in their eagerness to get into the game, trade technology for (what is usually limited) access. As domestic companies mature, the home government helps arrange cheap financing so that these companies start to win international business. At the same time the government coordinates the entry of these companies into the international market so that domestic companies don’t bid against each other and drive down prices unnecessarily.
This is a game that, historically, the Japanese and Koreans have played well. And the Chinese have clearly become masterful players.
The rise of the Chinese high-speed rail industry is built on China’s creation of a huge market for rail equipment of all kinds—everything from traditional rails, to rolling stock, to signaling equipment to high-speed equipment. China’s market for all rail equipment, running at about $10 billion a year on average between 2004 and 2008, is projected to grow to more than $50 billion by 2013, according to McKinsey & Co.
In 2010 China is projected to account for at least half of total global spending on rail equipment.
That huge domestic market, largely protected from competition except where the Chinese see a chance to acquire important technology, is the base that China’s rail companies are now using to bid for high-speed rail projects in Brazil, Saudi Arabia, across Southeast Asia, and in the U.S. China South Locomotive & Rolling Stock, for example, is one of the companies competing for the $8 billion of taxpayer money targeted for high-speed rail projects in the United States.
Which might lead you to ask, Where’s the United States in all this?
Government efforts to create a domestic high-speed rail system are piddling and disjointed. $8 billion isn’t enough to fund a serious effort (We’ll leave aside here the important question of whether or not the United States with its massive investment in air travel and highways should invest massively in high-speed rail. With taxpayer money to invest in new sunrise industries finite—taxpayer pockets do have a bottom, you know—maybe the cash would be better spent on creating a wind or solar industry able to compete globally.) U.S. investment so far is not just too small, it’s disjointed with the government putting up just a small part of the cost of any system and leaving it to states and private investors to decide where to lay the tracks.
And just as important, the United States apparently hasn’t read the page in the manual that says, “After creating a domestic market, you must protect domestic players from overseas competition. The likely winners of that $8 billion in government money will be companies from Europe, Canada, Japan, China, and Korea.
That’s left U.S companies scrambling to partner with those overseas players. For example, General Electric (GE) the world’s biggest maker of freight locomotives, announced a partnership with the Chinese Ministry of Railways in November to manufacture equipment for U.S. high-speed rail projects. The Chinese, of course, want access to General Electric’s locomotive technology.
So how do you go about investing in the future of high-speed rail?
If you can buy H-shares, so called because they trade on the Hong Kong stock exchange, consider shares of China South Locomotives (1766.HK). The company is clearly one of two state-controlled companies that Beijing has designated to dominate China’s rail equipment sector. (The other half of this official duopoly, China CNR, only went public on Shanghai’s A-share market in December and is even tougher—close to impossible might be more accurate—to buy for U.S. investors. China South Locomotives also has an A-share listing.) The fact that China South Locomotives is part of a government-bless duopoly removes some of the problems investors face in deciding how to invest in China caused by the ever-changing relationship between privately-own and state-controlled companies in China. For more on that problem and the current state of the balancing act see my post of March 23 http://jubakpicks.com/2010/03/23/how-do-you-invest-in-a-country-such-as-china-thats-making-up-the-law-as-it-goes-along/ .
Daiwa Securities is projecting revenue growth for China South of 18.5% in 2010 and earnings growth of 39%.
China South operates what some market analysts call China’s leading research and development center for high speed rail. As best as I can tell China South has a larger market share than its competitor and has been growing market share in recent years. Like many industrial companies in China, China South has major “sideline” businesses—in this case in auto parts and wind turbines.
If you can’t get the H- or A-shares of these companies (or figure out how to buy Korea’s high-speed champion Hyundai Rotem on the Korean market, my next choice would be Germany’s Siemens (SI), which trades on the New York Stock Exchange.
Siemens’ rail business is one of the jewels in this industrial conglomerate. For example, late in 2009 Siemens won an order to supply $800 million in railroad equipment to Russia for use upgrading the rail infrastructure around the Solchi site of the next winter Olympics,
The problem with Siemens for investors is that the company isn’t a pure play in railroad equipment. On the plus side, a buy of Siemens gets you, besides the rail equipment business, a piece of the No., 2 gas turbine builder and a leader in nuclear reactor technology. Both are growth businesses right now, especially nuclear. But the established European, Japanese, and U.S. nuclear players are facing new competition from Korea. The sector was rocked recently when a large Gulf nuclear project went to a Korean led group. On the minus side you also get things like the company’s troubled joint venture with Nokia (NOK) in wireless networking equipment.
My third suggestion is a more concentrated U.S. rail equipment player but one that is just getting into the Chinese rail equipment market. In April 2009 Wabtec (WAB) formed a joint venture with Shenyang Locomotive and Rolling Stock Railways Brake Co., the largest maker of railroad brakes in China. Wabtec, which has its roots in the historical Westinghouse brake business, is a leader in braking systems, the complex gear that enables you to not just stop a train but also to manage its motion electronically. The company has been expanding its freight (about 1/3 of revenue in 2009), and transit (inter and intra-city) businesses overseas. Recently, for example, Wabtec announced deals to supply equipment in Ireland and Turkey. The joint venture in China is a huge leap into a big market where Wabtec’s technology could win it significant business.
Watch this space to see if more rail and high speed rail opportunities open up for investors.
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