Fitch Ratings has assigned Zhejiang Expressway Co., Ltd.'s (ZJE, A+/Stable) USD470 million 1.638% bonds due 2026 a final rating of 'A+'.
The Outlook is Stable.
The bonds are rated at the same level as ZJE's senior unsecured rating because they constitute its direct and senior unsecured obligations.
The ratings are equalised with the ratings of ZJE's parent, Zhejiang Communications Investment Group Company Limited (CICO, A+/Stable), the largest provincial government-owned entity in China's Zhejiang province, in accordance with Fitch's Parent and Subsidiary Linkage Rating Criteria. This is due to ZJE's strong operational and strategic linkages with CICO, and the consistent tangible support that ZJE receives from its parent.
Fitch assesses the underlying credit profile of ZJE at 'bbb+', which reflects the credit quality of ZJE's toll-road business and the securities business operated by its subsidiary, Zheshang Securities Co. Ltd. (ZSS).
We assess the toll-road business under our Toll Road, Bridges and Tunnels Rating Criteria while the credit quality of ZSS is assessed under the agency's Non-Bank Financial Institutions Rating Criteria. The underlying credit profile of ZJE is underpinned by its robust road network, with the majority strategically located in Zhejiang, which benefits from the economic prosperity of the Yangtze River Delta. The risk profile is heightened due to the exposure to the securities business, which we believe is more volatile and cyclical than the toll-road operation despite the prudent risk-management strategy adopted by the company.
Nevertheless, the business diversification meant the company was less affected by the coronavirus pandemic in 2020, when the toll-road business was hit badly by a 79-day toll holiday. The financial profile of the toll-road business is robust with five-year average net debt/EBITDA at 2.5x in Fitch's rating case.
KEY RATING DRIVERS
Strong Linkage with Parent
ZJE is a strategically important subsidiary of CICO and is highly integrated with the parent's core business. CICO has consistently provided tangible support to the subsidiary, including injecting 89% of the toll roads controlled by ZJE from 2013. We expect the support to continue. ZJE accounted for 55% of CICO's net profit and 41% of EBITDA in 2019, which we deem substantial. ZJE is CICO's only listed platform outside of mainland China and gives the parent access to global capital markets.
ZJE and ZSS are pioneers in infrastructure REITs in China and provide expertise about innovative financing to the group. ZJE's stable cash flow to CICO and its critical role in monetising toll-road assets support CICO's other less profitable businesses and its massive capex for roads and railways. ZJE's failure would impair CICO's operations, and undermine its reputation and ability to borrow. Therefore, we regard the overall linkage between parent and subsidiary as strong, with strong incentive for the parent to provide support if needed. As a result, we equalise ZJE's ratings with the credit profile of CICO.
Exposure to More-Volatile Securities Business
Fitch considers ZSS a mid-tier Chinese securities firm with a moderate franchise. Its business model is more reliant than that of peers on more-volatile capital market activity and it has a higher risk appetite. ZSS also operates in a developing, but improving, regulatory environment. Asset quality has the potential to be more volatile through economic cycles with potential losses from unexpected market shocks. Its earnings and profitability profile is weaker than that of higher-rated peers and susceptible to market changes in light of its reliance on the brokerage, proprietary trading and futures-related business. However, the potential losses stemming from credit and market risks are mitigated by its lower leverage.
Large, Robust Network, Proven Traffic - Volume Risk: Stronger
The 'Stronger' volume risk is supported by the robustness of ZJE's road network, which has a long operating history and strong traffic growth. Most of its assets are essential roads with large commuter bases and limited alternatives. The traffic on its two flagship roads have risen by a CAGR of 7% since 2001. ZJE's traffic volume was resilient through the Covid-19 crisis and quickly returned to pre-crisis levels as early as May 2020. Traffic on ZJE's roads will continue to benefit from the robust economic growth in the Yangtze River Delta region.
Limited Tariff-Setting Ability, Government Intervention - Price Risk: Weaker
The price risk is constrained by the lack of transparency and predictability in the regulatory framework, compared with more robust regulatory environments that provide more protection to investors. All toll roads in China charge rates enforced by each provincial or municipal government. Most existing tolls have not increased for years and are unlikely to rise in the foreseeable future. In the past, authorities would impose tariff discounts or exemptions, which sometimes left operators uncompensated for losses. We consider the intervention a weakness.
However, we believe the regulatory environment in China is improving and the government is making efforts to balance the interests of operators and users. For instance, operators expect to be compensated by their respective provincial governments for revenue losses following the toll holiday in 2020.
Well-Maintained Network, Low and Predictable Capex - Infrastructure/Renewal: Stronger
ZJE's road network is well-maintained and in good condition. Management has considerable experience in managing and operating the network. The company has successfully delivered large expansion projects. ZJE develops a detailed capital and maintenance plan for each road in advance every year. Most of the maintenance works are of low complexity and highly predictable. Capex in the next three years will be low and mainly sourced from internally generated cash flow.
Corporate Borrower, Limited Refinance Risk - Debt Structure: Midrange
ZJE's debt structure is typical of a Chinese corporate borrower as it is funded by non-amortising debt with few of the protective covenants typically seen in project finance structures. Refinancing risk is mitigated by the company's ample liquidity, comprising cash and significant standby bank facilities, and a record of prudent debt management and solid access to funding channels. About 29% of ZJE's debt at 31 December 2020 was benchmarked to the loan prime rate (LPR), exposing ZJE to interest-rate risk. However, Fitch believes the risk is manageable as the LPR is infrequently adjusted - the last change was in April 2020 - and interest rates are likely to remain low. Nevertheless, Fitch considers the risk in the rating case by adding a stress of 200bp to existing rates.
The closest peers to ZJE are Yuexiu Transport Infrastructure Limited (YXT, BBB-/Stable) and Shenzhen Expressway Company Limited (SZE, BBB/Negative, underlying credit profile: bbb).
YXT and SZE are established companies that own and operate toll roads in China. ZJE has the largest road network among the three. SZE and ZJE share some similarities. Both companies have 'Stronger' volume risk assessments as the majority of their assets are essential roads that are in economically vibrant regions and have limited competition. They have substantial exposure to non-expressway businesses, which result in higher overall risk.
Unlike ZJE and SZE, YXT is highly focused on toll-road operations. It has geographical diversity and a longer remaining concession life. Fitch's rating case projects the average five-year net leverage of SZE and YXT at 4.2x and 4.9x, respectively. SZE's lower net leverage and stronger volume assessment justify a rating that is a notch higher than that on YXT. The leverage profile of ZJE's toll-road business is much stronger than SZE's, but its underlying credit profile is only one notch higher than that of SZE due to its exposure to the riskier securities business.
Factors that could, individually or collectively, lead to positive rating action/upgrade:
Positive rating action on CICO, provided the linkages between CICO and ZJE remain intact.
An upgrade is unlikely, as ZJE's ratings are currently in line with the Chinese sovereign rating (A+/Stable).
Factors that could, individually or collectively, lead to negative rating action/downgrade:
Negative rating action on CICO, provided linkages between CICO and ZJE remain unchanged.
Weakening of linkages between CICO and ZJE
BEST/WORST CASE RATING SCENARIO
International scale credit ratings of Sovereigns, Public Finance and Infrastructure issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of three notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.
ZJE is the largest listed toll-road operator in China in terms of total assets and net profit. It invested in 10 expressways with a total mileage of 1,197km (including an associate and a joint venture). ZJE's two flagship roads, the Shanghai-Hangzhou-Ningbo Expressway and Shangsan Expressway, accounted for 51% and 15%, respectively, of its toll revenue in 2019.
ZJE also owns 40.34% of ZSS, a medium-sized securities firm listed on the Shanghai Stock Exchange. The securities business contributed 28% and 23% of ZJE's consolidated revenue and net profit, respectively, in 2019.
The proceeds from the issuance of the US dollar notes will be used for debt refinancing and general corporate purposes.
Fitch has developed a base case and rating case to analyse the financial profile of ZJE's toll-road business (excluding ZSS), incorporating management's projections, Fitch's own assumptions and peer analysis.
The management case assumes a substantial rebound in revenue in 2021 after the 18% drop in 2020 due to the Covid-19 pandemics, which is supported by the traffic recovery in 1H21. The management case projects single-digit organic traffic growth from 2022, in line with its forecast for GDP growth in Zhejiang. Management also expects a few more mature road assets to be injected by CICO during the forecast period of 2021-2025, which will increase the total mileage of the network and provide additional cash flow immediately after consolidation. Management adopts an EBITDA margin that is in line with the historical level.
The Fitch base case applies a 5% haircut to revenue, reduces the EBITDA margin by 2pp, stresses capex by 5%, and adds 200bp to variable interest rates. The Fitch base case results in a net debt/EBITDA of 2.0x on average for the forecast period.
The Fitch rating case applies an additional 5% stress to the revenue, another 3pp reduction in the EBITDA margin and a further 5% stress to capex compared with the base case, which leads to net debt/EBITDA of 2.5x on average for the forecast period.