Toll road shares tipped to shine in China’s protracted bear market

Profits seen as being less sensitive to economic slowdown

PUBLISHED : Thursday, 04 February, 2016, 9:31am
UPDATED : Thursday, 04 February, 2016, 10:13am

As China’s seventh-month-long equity bear market drags on, no sector is immune to a sell-off, but some sectors, such as toll roads, are better defended than others against the headwinds of economic slowdown.

Although toll road shares have already outperformed the market, some analysts say they are still worth investing in amid heightened market volatility and uncertainty due to their relatively stable and high dividend payouts and the fact that their profits are less sensitive to the economic slowdown.

“Amid China’s worsening macro[economic] environment and weak market sentiment, we believe the toll road sector will shine with its defensive attributes, as it has done in previous market downturns,” Citi analysts said in a research report.

“Underpinning the sector are stable traffic volume, little downward pressure on tariffs, high dividend yields and negligible policy headwinds.”

They noted that during bear stock market periods in the past decade, toll road shares had generally outperformed the wider Hang Seng China Enterprises Index (HSCEI) that tracks Hong Kong-listed mainland firms, except in 2011 when they encountered unfavourable industry policies.

In the latest bear market, Shenzhen Expressway’s Shanghai-listed shares have fallen 30 per cent since mid-June, compared with a 46 per cent slump in the Shanghai Composite Index.

Its Hong Kong-traded shares have retreated 14.4 per cent in the period, against a 42.6 per cent fall in the HSCEI.

An extension will result in asset depreciation charges being spread over a longer operating time frame, which will enhance profitability
China International Capital Corp analysts

Jiangsu Expressway has tumbled 28.9 per cent in Shanghai but only 7 per cent in Hong Kong, but Hong Kong-listed Zhejiang Expressway tumbled 41 per cent, dragged down by its 52 per cent holding in Zheshang Securities’ stock brokerage business, which has been hit by the market rout.

The three firms are expected to pay dividends amounting 45 per cent to 70 per cent of their net profits this year, making dividend yields of 5 per cent to 6 per cent.

According to an Industrial Securities research report, mainland China’s toll road passenger traffic fell 0.7 per cent in the first nine months of last year, against 2.2 per cent growth in the year-earlier period, while freight traffic growth slowed to 6 per cent from 9.2 per cent.

But listed toll road firms’ better quality assets meant their traffic volume and toll revenue maintained average growth of 5 per cent in the first nine months of last year.

Citing a strong correlation between toll road operators’ share prices and China’s gross domestic product figures in the past 13 years, Citi analysts said they expect the listed operators to be able to maintain average annual revenue growth of 4 per cent in the next few years, with flat toll fees but rising traffic volumes.

They said last year’s weak passenger traffic was due to the economic slowdown, weak car sales growth and competition from high-speed railways, while freight volume growth remained healthy thanks to booming e-commerce traffic.

Although the toll road sector has had its fair share of policy and road planning risk, in the form of government-initiated asset buy-backs that cut short operating time frames, adjustment of toll fees and traffic-reducing road diversions, the policy landscape is on course for improvement.

Last July, the Ministry of Transport issued draft amendments on policies, including extension and relaxation of strict caps on operators’ concession periods, currently set at 25 years for eastern regions and 30 years for central and western ones.

Under the proposed amendments, the longest operating period is 30 years under “normal circumstances” and can exceed 30 years for “mega” toll roads, while concession periods can be adjusted when expressways are expanded or rebuilt. Compensation will also be granted to operators for government-stipulated toll-free public holidays, and compensation will be given in cases where operators’ concessions are ceased by governments.

The greater flexibility for toll road operators to apply for an extension of concession periods could enhance their projects’ value by 20 per cent for every five years of extension, China International Capital Corp (CICC) analysts said in a report.

“An extension will result in asset depreciation charges being spread over a longer operating timeframe, which will enhance profitability,” they said, adding depreciation accounted for some 60 per cent of toll road operators’ total operating costs.

Citi analysts have a “buy” recommendation for Jiangsu Expressway and Shenzhen Expressway, saying the former is expected to see a 1 percentage point gain in tariff growth after the Shanghai Disneyland theme park is opened in June, and the latter is expected to see a relatively high 6.6 per cent average annual revenue growth this year and next year thanks to its diversified toll road portfolio.

It has a “neutral” rating on Zhejiang Expressway, citing a heavy exposure to the brokerage business that accounted for 49 per cent of its revenue in the first half of last year, and a poor acquisition record including its newly acquired Hanghui Expressway that posted weak traffic growth.

Shenzhen Expressway said on Friday it expected to post a 20 per cent to 40 per cent drop in net profit for last year from 2.19 billion yuan in 2014, due mainly to 390 million yuan of impairment arising from traffic reduction at one of its projects due to road diversions.