China Economy

Stock Watch: Chinese toll companies

PUBLISHED : Monday, 17 December, 2012, 12:00am
UPDATED : Monday, 30 May, 2016, 5:01pm

In these times of low interest rates and volatile share markets, investors keep coming back to dividend stocks. A near inescapable market logic drives this. Low interest rates make returns on high-grade bonds unattractive. In fact, once inflation is factored in, the returns are typically negative and the bonds risk losing value when interest rates rise. Equities are appealing but risky.

Dividend stocks, however, generally return above inflation, and offer equity returns should the share market go on an extended rally.

For those reasons Hong Kong investors have been piling into local dividend stocks, such as real estate investment trusts (yielding about 5.4 per cent) Hong Kong banks (about 3.6 per cent), and power firms such as  CLP (3.9 per cent) and  Power Assets (3.5 per cent).

However, if you are a dividend fan, another class of stock deserves a closer look: mainland toll-road companies. These pay out an average dividend yield of about 6.5 per cent (see table) and offer a chance of gains should the mainland economy turn around.

Toll roads are typically safe earners, if dull and low growth. They collect cash in a highly predictable fashion. This stability enables firms to pay out a high proportion of their earnings in the form of dividends. It also allows the companies to obtain cheaper debt financing (banks and bond investors see them as a safe bet for repayment), enhancing returns.

Mainland toll-road firms are exposed to volatile mainland economic growth, and are therefore seen to be more volatile. But this could be taken as a positive. Mainland toll-road stocks were down this year as economic growth slowed. Should the economy rebound, so might the stocks.

Indeed, these counters are a good proxy for economic growth. As the economy expands, construction, manufacturing and tourism pick up, and more people and goods go on the move, meaning higher toll income.

There is also a currency effect. The cash flows of these toll-road operators are in renminbi. Investors looking at the yuan appreciation story would see something of value in the stocks.

However, there is no such thing as a free lunch. Toll-road stocks can capture wider growth but they are also vulnerable to downturns. They are unusually volatile for a dividend stock - their share prices have dropped by an average of  about 24 per cent over the past two years. The Hang Seng Index dropped about 3.5 per cent over the same period.

This is mainly because growth in toll revenue stagnated or declined after hitting a peak in 2010 as the effects of a four trillion yuan  (HK$4.9 trillion) stimulus package in the mainland (to ward off the effects of the 2008-09 global credit crisis) wore off, resulting in a slowdown in mainland economic growth.

The HSBC China Purchasing Managers' Index (PMI), an indicator of manufacturing activities and the wider economy, confirms this story. The index hit a peak in 2010 but, from October 2011, it trended below 50, indicating managers foresaw a slowdown in manufacturing. The share prices of the mainland toll firms largely mirrored this PMI performance, suggesting their fates were tied to the wider economy.

Policy shifts also hit the stocks. In June 2012, the Guangzhou provincial government reduced tariffs and the central government announced this August that all small passenger vehicles could use  certain toll roads for free during holidays such as Lunar New Year, Ching Ming Festival and Labour Day.

Earnings of mainland toll-road operators are expected to decline by about  10.3 per cent this year, according to Bloomberg. Some of these counters trade at significant discounts to their net asset values, or the presumed value of the firm if it were forced into liquidation. Such discounts usually indicate investors expect a stock will suffer slower growth and diminished returns.

But the toll stocks' depressed price and gloomy outlook may offer the perfect time to buy. Think of it this way: while their share prices have declined, dividends per share have stayed largely steady. This has translated into a rising dividend yield. The yields of mainland toll-road stocks were only about 5 per cent  in 2010;  today they range between 6 per cent and 8 per cent.

It is difficult to say if toll revenues will start growing soon based on the monthly statistics released by the toll-road operators. But looking at the bigger picture, it is encouraging that the HSBC PMI Index reached a  13-month high of  50.4 last month, the first time it exceeded the 50 mark since October 2011, indicating that manufacturing is picking up.

Together with their attractive and sustainable dividend yields and yuan denominated cash flows, these stocks may be a decent calculated bet for investors seeking yields and exposure to the possibility of improved mainland economic growth.