Chinese truck maker takes IPO on the road

Sinotruk launches its $1.2 billion offering amid increasing market volatility and will have to fight for investor attention with several other transport-related companies.
ChinaÆs largest heavy truck manufacturer Sinotruk (Hong Kong) is the latest company to kick off the institutional roadshow for an initial public offering in what promises to be a month heavily focused on transport.

Also in the market is Sinotrans Shipping, a dry-bulk shipping company that is looking to raise up to $1.47 billion in an offering that closes on Thursday. And yesterday, China Railway Group also kicked-off pre-marketing for the H-share portion of a near simultaneous A- and H-share listing that could raise a combined $3.5 billion. Being Asia's largest construction contractor in terms of revenues, China Railway Group should perhaps be viewed as an infrastructure play rather than a transport play, but in any case it is viewed as a key beneficiary of the governmentÆs plans to expand and boost the use of the countryÆs railway network.

Meanwhile, there is still a chance that North China Shipping, which also focuses on dry-bulk, will be able to bring its $700 million to $800 million IPO to market before the end of the year. Investors are also awaiting the listing of a second builder of railways in the form of China Railway Construction, although some sources say this is more likely to come in early-2008.

Brought to market by China International Capital Corp and JPMorgan, Sinotruk will be the only Hong Kong-listed company to focus purely on the manufacturing of heavy duty trucks and, with a market share of about 20%, it is viewed as a good way to gain exposure to the growth in ChinaÆs fixed-asset investments. FAI has been on a steady increase since 2001 in line with the rapidly expanding economy, reaching Rmb7.8 trillion ($11.05 trillion) in the first nine months this year, compared with Rmb10.9 trillion for the full year 2006.

ôDemand for heavy trucks is highly correlated with fixed-asset investments, which has been, and is expected to continue to be, a key driver of the Chinese economy,ö says a source familiar with the company. ôSinotruk is a good way to play this theme as there arenÆt that many other good proxies. Property is one, but it is subject to various government policies and controls.ö

The company, which aside from actual trucks also makes key components such as engines, cabins and axles, is looking to raise between HK$7.02 billion and HK$9.04 billion ($900 million to $1.16 billion) by selling 31.8% of its share capital. It is offering 702 million new shares at a price between HK$10 and HK$12.88.

At that price, sources say it is valued at 14.6 to 18.8 times its 2008 earnings, based on the average estimate by the two bookrunners. At present, this valuation range gives some flexibility of how to price the deal in relation to Hong Kong-listed Weichai Power, which is considered the closest comparable. Weichai, which started as an engine manufacturer but has migrated into the production of heavy trucks as well, currently trades at about 16.5 times after falling 11.5% over the past week.

Analysts argue that Sinotruk deserves to trade at a premium to Weichai because of its stronger market position and greater growth profile, but in the current volatile market environment the company may well have to accept a discount for the IPO. According to a syndicate research report dated early this month, the global commercial vehicle manufacturers trade at an average 2008 price-to-earnings multiple of 14.5 times, while the Asian players fetch an average multiple of 12.9. The latter include KoreaÆs Hyundai Motor and Kia Motors, IndonesiaÆs Ashok Leyland, MalaysiaÆs UMW Holdings and IndiaÆs Tata Motors.

To help support the offering, Sinotruk has brought in eight cornerstone investors, who will each buy $25 million worth of shares. This will see them take between 17.2% and 22.2% of the total deal, depending on the final price. The cornerstones include all the usual suspects: Government of Singapore Investment Corp, the Kerry group, Chow Tai Fook, China Life Insurance, Citic Pacific, BOC Investment, Dickson Poon and û as one entity - the Li Ka-shing Foundation and a subsidiary of Cheung Kong (Holdings).

The offering will have the usual 90:10 split between institutional and retail investors, but standard clawback triggers will apply meaning the retail tranche may increase to 50% of the pre-shoe deal size in case of strong demand. The greenshoe amount to 15% of the base deal and could boost the total proceeds to as much as $1.33 billion. If fully exercised, 35% of the Sinotruk will be in public hands.

At present, 100% of the company is owned by China Heavy Truck Group, which also manufactures heavy trucks, but with a focus on the high-end of the market. According to sources, this business, which includes a small-scale joint venture with SwedenÆs Volvo, was left outside the listing vehicle because of the limited demand for these trucks in China. The portion of the business left with the parent accounts for only about 10% of the revenues for the entire group.

Sinotruk is expected to see earnings growth in the 20% range which, aside from the increase in FAI, should be supported by the expansion of ChinaÆs highways and expressways, which will make long-haul goods transport on the roads more efficient and thus increase the demand for new vehicles. More than 75% of all cargo transports in China (in terms of revenues) are done by road and the government aims to connect 90% of all cities with a population above 200,000 by highways by 2010.

The government is also cracking down on overloading of medium trucks, which together with the increasing practice of charging road tolls based on the weight of the load rather than the rated capacity of the vehicle, means it makes more sense to use heavy trucks.

ôIn developed markets the demand for heavy trucks is driven primarily by replacement needs, but in China it is supported both by new customers buying new trucks and by replacements,ö the source close to the company says. ôThis means the cyclicality of the business isnÆt as pronounced and probably not as big a concern for these guys (as for manufactures in more developed markets)."

"If you believe in the China growth story, then there shouldnÆt be much doubt about this company,ö he adds.

However, the cyclicality of the market is still considered one of the key risks as the demand for heavy trucks do fluctuate not only with the growth in FAI, but with industrial production and ChinaÆs overall economic development as well. Fuel price shortages or fuel price increases are other potential risks to take into account. Sinotruk also has a high gearing of about 190% at the end of last year.

In terms of the companyÆs own position in the market, it is backed by an extensive sales and after-sales service network with 66 sales offices and 800 independent dealerships. The company is also self-sufficient in terms of engine production, which is giving it a cost advantage compared with other truck manufacturers which gave to buy their engines from third parties. The same goes for cabins, axles and truck frames.

Sinotruk has also started to make inroad into overseas markets over the past few years and according to one source it has a strong footprint in the Middle East and is making good progress in Russia. These two markets together with Southeast Asia are its main focus of expansion outside of China, although it currently exports heavy trucks to over 30 countries and regions. In the first nine months this year, exports accounted for 15.8% of its total revenues, up from 11.4% in 2006.

The retail offering will open on Thursday and close on November 20. The institutional order books will finish a day later and the final price is expected to be determined after the US close on November 21. The trading debut is scheduled for November 28.
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