2021 results in line with preannouncement

Traffic Control Technology (TCT) announced its 2021 results: Revenue rose 27% YoY to Rmb2.58bn, and net profit increased 23% YoY to Rmb291mn, in line with its preannouncement. In 4Q21, revenue rose 9% YoY to Rmb857mn, and net profit grew 1% YoY to Rmb109mn.

Gross margin expanded on improving product mix. Revenue of the general contracting business of signal systems rose 23% YoY to Rmb2.28bn in 2021. Revenue from sales of individual products increased 43% YoY to Rmb187mn, and that from maintenance services grew 39% YoY to Rmb113mn. Within the signal system business, revenue from communications-based train control (CBTC) and interchangeable communications-based train control (I-CBTC) systems fell 7% and 31% YoY to Rmb140mn and Rmb808mn, and revenue from fully automatic operation (FAO) systems increased 191% YoY to Rmb1.18bn. Revenue from the FAO system as a percentage of total revenue from signal systems expanded 30ppt YoY to 52%, driving up CTC’s overall gross margin by 3.2ppt YoY to 35.6%. In 2021, gross margins of CBTC and FAO systems expanded 2.7ppt and 2.6ppt YoY to 37.4% and 36.9%, but gross margin of I-CBTC systems fell 1.9ppt YoY to 29.9%.

R&D spending increased; cash inflows declined. In 2021, the expense ratio increased YoY, with the administrative expense ratio up 0.9% YoY and R&D expense ratio up 2ppt YoY. Due to the increased expenses, net margin narrowed 0.4ppt YoY to 11.3% in 2021. Net cash inflow from operating activities fell Rmb157mn YoY to Rmb190mn.

Trends to watch

Incremental mileage of China’s urban rail transit system to stay high in the 14th Five-Year Plan (FYP) period. According to the China Association of Metros (CAMET), China’s urban rail transit mileage reached 9,193km as of end-2021, an increase of 1,223km since the beginning of the year, and subway mileage was 7,254km, an increase of 972km in 2021. In 2021, the National Reform and Development Commission (NDRC) approved the construction of urban rail transit networks in 3 new cities, with total mileage of 315km and total investment of Rmb223.4bn. TCT won Rmb1.80bn of bids for new signal system projects and Rmb1.87bn of new contracts in 2021, both down about 20% YoY. Based on the approved projects, we expect China’s urban rail transit mileage to increase about 3,000km in the 14th FYP period.

Financials and valuation

To reflect the decline in new contracts for the coming two years, we lower our 2022 EPS forecast 16% to Rmb1.63, and introduce a 2023 EPS forecast of Rmb1.73. The stock is trading at 17.0x 2022e and 16.0x 2023e P/E. Based on our new earnings forecast and long-term development prospects of urban rail transit, we cut our target price 7% to Rmb32.54 (implying 20x 2022e and 19x 2023e P/E), offering 18% upside.

Risks

Tenders from downstream clients disappoint.