June 6, 2017 / 8:06 AM / a year ago

Fitch Affirms Shenzhen International Holdings at 'BBB'/Stable

(The following statement was released by the rating agency) HONG KONG/SYDNEY, June 06 (Fitch) Fitch Ratings has affirmed China-based Shenzhen International Holdings Limited's (SIH) Long-Term Issuer Default Rating (IDR) at 'BBB' with Stable Outlook. The affirmation reflects SIH's credit profile from its toll-road operations and logistics business at a 'BBB-' standalone rating, with a single-notch uplift for implied support from its 44.3% shareholder, Shenzhen's municipal government. SIH's stable toll-road operation is contributed by its 50.9%-owned Shenzhen Expressway Company Limited (SZE; BBB/Stable). SIH aims to increase its logistics business exposure in the medium term. We believe this carries execution risk and has a higher risk profile compared with the toll-road business. SIH's exposure in two property projects - the Meilin Checkpoint Urban Renewable Project (MCUR) and Qianhai project is credit neutral, as limited additional capex is required since SIH does not plan to develop these projects on its own. Instead, SIH may divest a portion of its exposure in MCUR in the immediate term. KEY RATING DRIVERS Stable Toll-Road Operations: SIH's toll-road operations accounted for over 70% of its 2016 operating profit and remain its key earning contributor, with the majority of earnings coming from SZE. Fitch expects cash generation from the expressway operations to remain strong, driven by SZE's acquisition of Yichang Expressway and organic growth of the existing expressways. We also expect a stable regulatory environment for expressway operators, with little negative regulatory changes in the near term. Sustainable Dividend from SZE: We expect SZE to continue providing stable dividends to SIH in the medium-term, provided SZE's financial profile remains strong, despite SZE's active large acquisitions and expansion into the environmental segment. We expect SZE's financial profile to remain at historical levels, with fund flow from operation (FFO) net leverage remaining below 4.0x (2016: 1.1x) and FFO interest coverage above 4.5x (2016: 6.5x). We believe SZE's strong financial profile will enable a moderately increasing dividend flow to SIH. Harvesting from Real Estate Projects: We do not expect SIH to make significant additional investments into its real estate projects, as management has said the majority of capex has been paid and land premium payments have been settled via land swaps, profit sharing and momentary compensation. SIH agreed with Shum Yip Land Company Limited for the joint development of phase one of the Qianhai residential project, which measures at 53,000 square metres in gross floor area. SIH has also classified the MCUR as asset held for sale. We expect SIH to gradually monetise the profits from its Qianhai project as early as 2019, when it is ready for pre-sale. Significant realisation of MCUR may be sooner, given that SIH's directors have approved a plan to dispose of more than 50% of the company's equity interest in the project to third-party real estate developers in 2017. The book value of MCUR is HKD4.4 billion, representing the land premium and original land-use rights. Shenzhen's booming real estate market implies a potential for substantially higher valuation of MCUR than its book value. High Logistics Capex: SIH plans to develop more than 17 integrated logistics hubs across China by 2020, four of which have been completed and became operational in 2016 and another five of which will be completed by end-2017. We estimate SIH will invest more than HKD6 billion of total capex in its logistic business in the next three years. Building the logistic business carries execution risk and the segment has a higher risk profile compared with the toll-road business. If SIH successfully executes the build-up of its logistics business, conservatively, we believe its EBITDA contribution can increase to around HKD600 million in 2019, from around HKD430 million in 2016. Robust Standalone Financial Profile: We view SIH's standalone profile as robust. Its financial profile, excluding SZE, was net-cash positive at end-2016 due to large cash in-flows from the government to compensate for making Longda Expressway toll-free. We expect SIH's elevated capex will require some debt financing. However, interest coverage/dividends (primarily from SZE and Shenzhen Airlines) are likely to remain at over 5.0x for the next two years (2016: ~6.6x). We also expect SIH's consolidated FFO net leverage to remain below 4.0x (2016: 0.9x) for the next three years, while consolidated FFO interest cover is likely to remain above 4.5x (2016: 6.8x). The weakened credit profile beginning in 2017 also incorporates SZE's major acquisitions and elevated capex programme. SIH's consolidated credit metrics remain within our negative guidelines. Support from Shenzhen Government: SIH has received tangible support from the Shenzhen State-Owned Assets Supervision and Administration Commission, including a capital injection with the conversion of HKD1.7 billion in convertible notes into equity in 2010 and the extension of the maturity of a CNY863 million shareholder loan in 2008. Fitch has limited the rating uplift to one notch because SIH is mainly operated as a commercial entity, as reflected in its robust 'BBB-' standalone rating, and is less reliant on state support than a typical government policy vehicle. DERIVATION SUMMARY SIH's IDR of 'BBB' reflects its credit profile from its toll-road operations and logistics business at a 'BBB-' standalone rating, with a single-notch uplift for implied support from its 44.3% shareholder, Shenzhen's municipal government. The expressway segment mainly consists of contributions from its 50.9% owned SZE, which translates to a high level of cash leakage to minority shareholders. SIH is also subject to the higher business risk profile of the developing logistics business. However, Fitch believes SZE's stable dividend payout and the strong financial profile of SIH's non-SZE business provide some support to mitigate the aforesaid risks. As such, the standalone 'BBB-' rating is appropriate. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: - Moderate EBITDA growth from SZE's expressway operations, translating into a stable dividend payout. - Realisation from disposing up to 50% of its equity MCUR in 2017 at book value. - The government buying back four expressways - the Yanba, Yanpai, Nanguang and Longda Expressways - at end-2018. - Total capex of over HKD3.5 billion per year in 2017-2019, roughly half from expressways (mainly the Outer Ring Road Project) and the rest from building out its logistic parks and integrated logistic hubs. - Total acquisitions of more than HKD6 billion in 2017 from SZE, comprised of the Yichang Expressway and Chongqing Derun Environment Co., Ltd. RATING SENSITIVITIES Developments that May, Individually or Collectively, Lead to Positive Rating Action - Successful execution of SIH's expansion strategy for the logistics business, provided SIH's consolidated financial profile remains in line with Fitch's expectations. - An upgrade of SZE's ratings, including an improvement of its credit profile, which will be evident if its FFO interest coverage rises above 6.0x (2016: 6.5x) and its funds from operation (FFO) adjusted net leverage falls below 2.0x (2016: 1.1x) on a sustained basis. - Positive free cash flows at the SIH level, provided there is are no large business risk increases from its non-toll-road operations. - Strengthening of linkages between SIH and the Shenzhen municipal government. Developments that May, Individually or Collectively, Lead to Negative Rating Action - Weakening of SIH's operating or financial risk profile, such as large debt-funded investments in businesses of a higher risk profile than its established expressway operations. This may be reflected in SIH's consolidated FFO-adjusted net leverage rising above 5.0x (2016: 0.9x). - Downgrade of SZE's ratings, including a deterioration in its credit profile that would be evident in its FFO interest coverage falling below 3.0x and FFO-adjusted net leverage rising above 4.5x for a sustained period. - Adverse developments at SZE that affect SIH's ability to access operating cash flows, such as tighter debt covenants at the project level. - Weakening of linkages between SIH and the Shenzhen municipal government. LIQUIDITY Comfortable Liquidity: SIH's consolidated short-term debt amount to HKD4.8 billion, against HKD9.8 billion of readily available cash. 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