Fitch Downgrades Shenzhen International to 'BBB-'; Outlook Stable

Shenzhen International Holdings

28/05/2018 09:32

(The following statement was released by the rating agency)


Fitch Ratings-Hong Kong/Sydney-May 28: Fitch Ratings has downgraded the 
Long-Term Issuer Default Rating (IDR) on Shenzhen International Holdings Limited 
(SZIH) to 'BBB-' from 'BBB' and removed the rating from Rating Watch Negative 
(RWN). The Outlook is Stable. 

The rating of SZIH is based on its standalone credit profile without any uplift 
for implied support from its ultimate controlling shareholder, the Shenzhen 
municipal government in China. The removal of the one-notch uplift reflects our 
view that the shareholder's incentive to support and its linkages with the 
issuer are not strong enough to afford a rating uplift. This assessment is in 
line with Fitch's new Government-Related Entities Rating Criteria (GRE 
criteria). We placed the SZIH rating on RWN on 29 November 2017 after the 
release of the exposure draft of the GRE criteria.

KEY RATING DRIVERS

SZIH's rating reflects the combined credit profile of its toll-road operations 
and logistics business. The Shenzhen-based company is a medium-sized 
infrastructure company with exposure to toll-road operations via its 51.2%-owned 
subsidiary, Shenzhen Expressway Company Limited (SZE; BBB-/Stable) and a 
high-standard logistics facilities business. The company is also a passive, 
minority investor (49% stake) in Shenzhen Airlines. SZIH's 73% of revenue and 
69% of EBITDA in 2017 were derived from the toll-road business. The growth of 
SZE's toll-road operation has been robust and SZE continues to be the major cash 
flow contributor to SZIH although the company aims to increase the revenue 
contribution from the logistics business to 30%-40% by 2020. 

Strategic, Robust Expressway Network - Revenue Risk (Volume): Midrange

The volume risk factor is deemed as midrange, which is a reflection of the 
company's robust expressway portfolio, although it is constrained by the 
company's expanding but more cyclical logistics business. SZE's expressway 
network comprises 16 expressways and bridges (excluding the three toll-free 
expressways) with a total mileage of 546 km (65.7 km under construction) and an 
average concession life of around 12 years. The majority of its core assets are 
strategically spread across wealthy Guangdong province, including Shenzhen city, 
while three are located in central China. The operating portfolio includes key 
arterial roads with a large commuter base and limited competition. The road 
network has exhibited strong growth, with average annual traffic growth of 10% 
over the past 10 years; however its resilience has not yet been tested in an 
economic downturn. Fitch has forecast real GDP growth for China of 6.5% in 2018 
and 6.1% in 2019. Toll rates on the network are generally low due to 
restrictions, and sometimes subject to reductions imposed by the government.   

China's logistics industry has been growing rapidly over the past decade and the 
development of the industry was listed as part of the nation's economic 
development plan. The outlook of the industry is favourable, driven by rising 
domestic consumption especially through e-commence and continued urbanisation. 
Nevertheless, the growth potential of the industry has also been attracting new 
entrants, which has intensified the competition. The logistics business of SZIH 
is currently of a small scale compared with the key market players and we 
believe the expansion of its network carries higher execution risk, which 
heightens the overall risk profile of the company compared with a pure toll-road 
operator. Thus, the company's increasing efforts in expanding its logistics 
business limit the overall volume risk to midrange.

Opaque Regulatory Framework - Revenue Risk (Price): Weaker

The price risk is a weaker attribute due to the lack of transparency and 
predictability in the regulatory framework. Toll-rate setting and adjustments 
are highly regulated by the government with little flexibility left for 
toll-road operators to recover higher costs due to inflation. Most of the 
prevailing toll rates have been unchanged for a number of years with no 
visibility of any hike in the future. A number of tariff cuts and toll-exemption 
policies were imposed by the government in the past, resulting in a decline in 
the overall average toll rate. 

Large-Scale, Debt-Funded Capex Plan - Infrastructure Development and Renewal: 
Midrange 

The aggregate capex between 2018 and 2022 is of a large scale, mainly comprising 
greenfield expressway projects and investments in logistic hubs. SZIH's 
expressway subsidiary, SZE, has considerable experience and expertise in 
delivering investment in its network and its capex plans are highly developed 
and detailed, and we anticipate about half will be funded from operating cash 
flows. The public-private partnership model utilised for greenfield projects 
provides reasonable risk allocation and a construction cost-sharing mechanism 
mitigates the construction risks faced by SZE and caps SZE's construction-cost 
obligation. The expansion expenditure is normally recovered through adopting the 
higher tariff standards that are applicable to wider roads. SZIH also has 
extensive experience in building logistic parks and hubs but the uncertainties 
of timing and costs in land acquisition for logistic hubs and the large 
debt-funded investments needed to accommodate the growth in the logistics sector 
constrain the risk factor to midrange.

Non-Amortising Uncovenanted Debt - Debt Structure: Midrange 

SZIH is a typical corporate borrower whose borrowings are predominantly not 
amortising with few of the protective covenants that would be commonly seen in a 
project finance-type structure. Refinancing risk is mitigated by the company's 
ample liquidity comprising cash and a substantial standby bank facility, a 
well-diversified schedule of bullet maturities, a record of prudent debt 
management and solid access to the capital market. More than half of the debt is 
borrowed at floating interest rates with the majority indexed to the country's 
benchmark lending rate. However, the benchmark lending rate has been unchanged 
since 2015 and Fitch expects it to remain stable in 2018 and 2019. The foreign 
exchange risk of its USD300 million bond is hedged by currency swaps and 
forwards. The recently issued USD300 million senior perpetual bond is unhedged, 
which exposes the company to currency risk, although we do not believe it is 
substantial.

Financial Profile 

In Fitch's rating case, we expect consolidated leverage, measured by net 
debt/EBITDA, to increase substantially to 4.5x in 2020 from 2.9x at end-2017 
after factoring in the aggressive capex plan of building two greenfield 
expressways by SZE and the nationwide logistics network by SZIH. We expect 
leverage will drop slightly from 2021 as the operation of the logistic hubs 
becomes more stable. However, at this leverage level there is limited headroom 
in the rating, which is vulnerable to negative rating actions if the economic 
environment deteriorates or investments are higher than we anticipated.

PEER GROUP

The closest SZIH peer is Yuexiu Transport Infrastructure Limited (YXT, 
BBB-/Stable) as the toll-road business remains SZIH's major earnings and cash 
flow contributor. SZIH has a larger portfolio with key assets strategically 
located in a well-developed region while YXT has better geographic diversity and 
a longer remaining concession life. SZIH and YXT share the same volume risk and 
price risk. YXT's infrastructure and renewal attribute is assessed as 'Stronger' 
because of the smaller scale and lower complexity compared with SZIH's 
substantial investment plan, which limits its infrastructure and renewal 
attribute to 'Midrange'. The debt structure and leverage ratio are not major 
differentiators.

RATING SENSITIVITIES

Future developments that may, individually or collectively, lead to negative 
rating action:

- An increase in projected five-year average net debt/EBITDA leverage to greater 
than 4.5x in the Fitch rating case

Future Developments That May, Individually or Collectively, Lead to Positive 
Rating Action:

- An decrease in projected five-year average net debt/EBITDA leverage to below 
3.0x in the Fitch rating case

CREDIT UPDATE

Performance Update

SZIH recorded high growth in 2017 with total revenue rising 25% and EBITDA 
gaining 13% yoy. The revenue of its toll-road arm, SZE, grew by 17%, mainly 
driven by inorganic growth from Yichang Expressway and Changsha Ring Road. 
SZIH's logistics segment posted strong yoy revenue growth of 49% from a 
significant rise in logistics-service revenue. However, the margin of logistics 
services is generally lower than other logistics businesses, resulting in a 
lower mix EBITDA margin for the logistics segment. Capex of HKD2 billion last 
year was mainly for the Outer Ring Road Project and new logistic hubs. SZE made 
substantial investments in acquiring two expressways and two environmental 
companies for a total of around CNY7 billion. The debt increased by HKD6 billion 
during 2017, mainly due to SZE's significant debt-funded acquisitions, which 
weakened leverage compared with a year earlier.

Fitch Cases

The Fitch base case assumes low-single-digit revenue growth in logistic parks 
and hubs, and mid-single-digit growth in logistics services and ports. Fitch's 
base case also incorporates mid-single-digit growth in toll revenue for the 
existing network in 2018 and 2022 from a year earlier, and high-single-digit 
growth for 2019-2021 after taking into account management's expectations of 
strong volume growth on the Qinglian Expressway and the Coastal Project. The mix 
EBITDA margin is projected to stay slightly above 50% in 2018 and 2019 and drop 
to around 47% thereafter as the logistics business's contribution to revenue 
increases. The income from non-controlling assets is projected to grow at a flat 
rate of 5%. The Fitch base case also takes into consideration the assumption 
that the Outer Ring Road Project will open to traffic in 2021.  Under the base 
case, leverage rises slightly to 3.5x in 2019 and gradually falls to 2.6x in 
2022. The projected five-year average leverage ratio is 3.1x in Fitch's base 
case.

The Fitch rating case takes a more conservative stand and incorporates a number 
of stresses, mainly including a lower revenue growth rate of 3% in logistics 
services and ports and income from non-controlling assets, 2%-5% drop in average 
toll per vehicle varied for each expressway, 3-5 percentage-point haircuts to 
2018-2022 EBITDA, a 100bp increase in floating interest rate, a 10% and 5% 
increase in the capex of the toll-road segment and logistic-hub investment, 
respectively, and a 5 percentage-point increase in the dividend payout ratio. 
The rating case results in a progressive increase in net debt/EBITDA to 4.5x in 
2020 followed by a slight drop to 4.3x and 4.4x in 2021 and 2022, respectively. 
The projected five-year average leverage ratio is 4.4x in Fitch's rating case, 
which provides limited headroom to support the current rating.

Asset Description 

SZIH is a company incorporated in Bermuda and is listed on the main board of the 
Stock Exchange of Hong Kong. The company, together with its subsidiaries and 
associates, is principally engaged in the investment, construction and operation 
of logistics infrastructure facilities, third-party logistics services, 
logistics information services, and toll-road businesses. 

Shenzhen Investment Holdings Company Limited, the controlling shareholder of the 
company, is a corporation wholly owned by the State-owned Assets Supervision and 
Administration Commission of the People's Government of Shenzhen Municipal and, 
as of 31 December 2017, held approximately 44.24% of the issued share capital of 
the company.

As of end-2017, SZIH operated three well-equipped logistic parks in Shenzhen and 
Yantai and eight China Urban Integrated Logistics Hub projects. The company 
signed investment agreements with relevant municipal governments in relation to 
the development of China Urban Integrated Logistics Hub projects across 20 major 
logistic-gateway cities. The total planned and acquired site area are 6.1 
million square metres and 2.7 million square metres, respectively, while the 
operating area is approximately 0.62 million square metres.

As of end-2017, SZE operated and invested in a total of 19 highway projects 
including three toll-free expressways. The total network is approximately 622 km 
(546 km excluding the three toll-free expressways), of which 65.7 km is still 
under construction. The average concession life is 12 years (the mileage 
weighted life is 14.5 years). It also participated in two regional urban 
infrastructure development projects, invested in four environmental protection 
and financial projects, and had five platform companies.

Contact: 

Primary Analyst

Sunny Huang

Associate Director

+852 2263 9979

Fitch (Hong Kong) Limited

19/F Man Yee Building 

68 Des Voeux Road Central, Hong Kong

Secondary Analyst

David Cook

Director

+61 2 8256 0363

Committee Chairperson

Danilo Quattromani

Senior Director

+39 (02) 879087 275

Media Relations: Leslie Tan, Singapore, Tel: +65 67 96 7234, Email: 
leslie.tan@fitchratings.com; Wai-Lun Wan, Hong Kong, Tel: +852 2263 9935, Email: 
wailun.wan@fitchratings.com.

Additional information is available on www.fitchratings.com

Applicable Criteria 

Government-Related Entities Rating Criteria (pub. 07 Feb 2018)

https://www.fitchratings.com/site/re/10019302

Parent and Subsidiary Rating Linkage (pub. 15 Feb 2018)

https://www.fitchratings.com/site/re/10019836

Rating Criteria for Infrastructure and Project Finance (pub. 24 Aug 2017)

https://www.fitchratings.com/site/re/902689

Toll Roads, Bridges and Tunnels Rating Criteria (pub. 22 Feb 2018)

https://www.fitchratings.com/site/re/10021263

Additional Disclosures 

Dodd-Frank Rating Information Disclosure Form 

https://www.fitchratings.com/site/dodd-frank-disclosure/10032399

Solicitation Status 

https://www.fitchratings.com/site/pr/10032399#solicitation

Endorsement Policy 

https://www.fitchratings.com/regulatory

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