Industry Report China Toll Road Toll Road Industry Analyst: Alan Lam (852) 2509 7589 alan.lam@gtjas.com.hk 12 Jan 2004 NEUTRAL Operation Reviews Hong Kong listed toll road companies performed favourably in the past year. Stock price of weighted average market value for 2003 grew 80.1%, higher than the 34.9% surge of Hang Seng Index during the same period. It shows toll road stocks outperformed the market and it is in line with our expectation last year. Benefited from the robust growth of import and export in China, sales increase of automobiles, market expectation on RMB appreciation and foreign capital chasing for Chinese stocks with stable income, prices of Chinese toll road operators recorded highs in general. The largest gainer among them is Guangzhou Traffic (1052). It doubled in price and Zhejiang way (0576) and Jiangsu way (0177) rose 81.7% and 79.3% respectively. Other medium/small toll road operators like Sichuan way (0107), Shenzhen way (0548) and Anhui way (0995) also surged 65.4%, 79.0% and 76.0% respectively. The six Chinese toll road operators announced their interim results of 2003 and the average profit growth rate achieved 51.9%. However, the high surge is mainly from the disposals of two national roads from Shenzhen way (0548) to obtain RMB586 million net profit. Excluding the exceptional profit, the major profit from these six operators for the first half 2003 just grew 9.6% yoy. The slowdown of average profit growth is mainly due to the SARS outbreak last year and maintenance works of several toll roads last year affecting the growth of traffic flow. Prospects of Toll Road Sector in 2004 Domestic demand supports the growth of traffic flow. We remain optimistic to the future development of mainland toll road industry. It is because the toll road sector enjoys the advantage of monopoly. Different industries in the mainland are facing foreign competitors flowing in the market on the premise of China accession to the WTO except the toll road sector. Toll road enterprises engaging in the provision of transportation and construction services are benefited from the accession of WTO. In addition, the robust consumption demand in China and the weakening US dollars also exaggerate the growth of China export and the traffic flow. Investors should not only keep an eye on the toll road projects which link with port operations, but also place attentions to the companies which have toll roads projects in Central West China. It is because toll roads in these areas may be benefited from the boosting consumptions in China. Sales increase of automobiles also benefits the traffic flow to rise. Jiangsu way first announced that the provincial government has approved to adjust the toll road fees within the province and standard prices of bridges. The adjustment includes the transportation fees of truck vehicles in the province will cost according to the truck weights. Moreover, it is suggested to enhancing the average fees per kilometer of its subsidiary toll See back of report for disclaimer www.gtjas.com.hk 1
expressways by 12.5%. We think other toll road operators will follow the steps to readjust toll road fees. It is because (1) China will standardize the toll road fees to strengthen monitoring overloaded vehicles. In addition, al provincial governments begin to folow the new standard of Vehicle Clasification for Fee-Tol Roads in which vehicles will be re-classified and toll road users will pay fees according to the weight of truck vehicles they used. We expect the policy may positively enhance the average toll fees. It is because toll road operators will introduce higher toll fees on overloaded truck vehicles in order to offset the extra maintenance works expenditures; (2) Inflation in China. The rise of inflation wil strengthen tol road operators bargaining power to encourage the provincial governments to raise toll fees. Nevertheless, most of toll road operators did not reduce their toll fees when there was deflation. So it is expected that the application for toll fees rise may hold off until after 2005. More competitions in toll road industry. The robust economy of China enriched the money pockets of provincial governments. They are going to expand toll road constructions. It is expected more toll road operators will face more competitions of increasing new toll roads constructions. Moreover, Guangdong Province has speeded up to consolidate the toll road networks and agreed to achieve the target of terminating 60 toll stations at the end of 2003. Shenzhen way (0548), NWS Holdings (0659), Hopewell Holdings (0054) and Shell Electric (0081) have sold their equity interests of secondary toll roads in mainland back to provincial governments. It reflects the policy is in a hurry to imply. The policy affects the listed companies which have secondary and tertiary toll roads in Guangdong province much more. It is because the cancellation of secondary toll road stations may divert the traffic flow. Core-profit of toll road operators in 2004 may rise 16%. Although the industry was affected by the SARS in 1H03, we estimate the average core profit in 2003 of the industry will grow 13.5%. It is expected to grow to 16% in 2004. It is because the companies benefit from the completion of maintenance works of major toll roads, extension of toll road constructions and continuous growing of traffic flow. RMB appreciation benefits the toll road stocks. Toll road assets are denominated in RMB. These assets provide stable growth of cash flow in RMB within a certain period, like bonds in RMB. So the RMB appreciation in general will benefit foreign shareholders. However, average liability ratio of Chinese toll road stocks is lower and they paid lots of foreign loans in recent years. The average foreign loan percentage at present is lower, so the rise of RMB exchange rate may slightly affect the profit and valuation (denominated in RMB) of Chinese toll road stocks positively. We think Zhejiang way (0576) will be mostly benefited from the RMB appreciation. Its profit for 2004 may grow 2% if RMB appreciates every 5%. On the other hand, the rise of RMB will bring adverse effects to Shenzhen way (0548) and Anhui way (see the following table). Effects of RMB Appreciation to State-owned Toll Road Operators Sichuan Jiangsu Shenzhen Zhejiang Anhui Code 107 177 548 576 995 Net Foreign Loans/(Investment) 92 3 (90) 644 (100) (mn RMB) Percentage of total net liabilities (%) 4% 2% n.a. 31% n.a. Effects of RMB appreciates 5%: EPS Changes (2004)* 1.3% 0.1% -1.2% 2.1% -1.5% EPS Changes (2005)* 1.0% 0.1% -1.1% 1.5% -1.3% Valuation per share changes (2004)* 0.1% 0.0% -0.1% 0.1% -0.1% Valuation per share changes (2005)* 0.1% 0.0% -0.1% 0.1% -0.1% *Note: Denominated in RMB and affect the profit of the year once Source: The Company, GTJAS (HK) Investors are advised to note the current toll road stock prices have factored the expectation of RMB appreciation. If RMB exchange rate moves up slightly, then the actual profit of toll road operators may follow to change slightly. See back of report for disclaimer www.gtjas.com.hk 2
Effects of mainland securities policy to toll road stocks. If the policy of QDII is launched as scheduled, the price spread of listed A share price and H share price will narrow down. Currently, there are three out of five Chinese toll road operators are A shares and H shares listed simultaneously, including Jiangsu way (0177.HK/600377.SS), Shenzhen way (0548.hk/600548.SS) and Anhui way (0995.hk/ 600012.SS). Average prices of these three H shares were 55% discounted to their A-share prices. Major shareholders of Chinese toll road stocks are provincial governments and their shareholdings range between 30-56%. It seems unlikely for them toreduce shareholding. In addition, the National Trafic Department s legal equity interests have transferred from the central government to Huajiang Transportation, the subsidiary of China Merchant Group. We believe it is less probability to see any substantial changes on shareholding. Effects of standard taxation to toll road stocks. Presently, some listed toll road stocks began to pay 33% standard tax rate to the nation. They include Jiangsu way (0177), Zhejiang way (0576) and Anhui way (0995). If the tax rate is standardized in future, it may reduce to 25-26%. The companies will be directly benefited from the policy. Their valuation will also be enhanced. However, Shenzhen way (0548) and Sichuan way (0107) are enjoying the tax concession. The average effective tax rates of the both companies are 15% and 17% respectively. A standard tax rate wil afect the companies future profit adversely. Investment Rating on the Industry Toll road stocks are having the advantages of high defensive. Despite the economic cycle reverted or the mainland government introduces some cool-down economic measures, the toll road sector was affected lesser than other cyclical industries. The price volatility of toll road stocks is also lower than other cyclical enterprises. The reduction of export tariff rebate rate may affect China export in certain extents and also the traffic flow. However, the strong mainland consumptions and sales increase of automobiles may partly offset the slowdown of export growth. For the foreign investors, having toll road stocks can directly enjoy the benefits from RMB appreciation. Therefore, toll road stocks will attract more foreign capital in the first quarter this year. Chinese toll road stocks have been re-valued time by time. It is the fourth consecutive year to outperform the market. Projected EPS for 2004 and 2005 of the toll road sector are 18.4x and 16.5x respectively. PEG is1.38x and dividend ratio for 2004 is 3.2%. Its valuation has already risen to the highest level during the boom in 1997. Its valuation is higher than the average valuations of HSI and China Enterprises Index. According to the discounted cash flow valuation and the 11% average discount rate, the average net asset value of toll road sector (according to the valuation at the end of 2004) has 1.7% discounts. Its current value has risen to a fair level. With the recovery of global economy, the economy enters into the cycle of rising interest rate and inflation in China, the interest rate in China may bottom out. The discount rate of toll road sector is unlikely to reduce. It may adversely affect the overall toll road sector. In addition, major toll roads of Chinese highway operators have more than 20 years operating period left. Moreover, the domestic needs were saturated. The current price of toll road stocks rose over than their net asset values. Investors can consider cash in the profit when the price surges. The investment rating Neutral for the tol road sector remains unchanged. To the investors who are optimistic to China s economy and RMB appreciation, tol road stocks many have longterm investment value. If we base on the Dividend Discounted Model, the long term growth rate of the toll road sector s dividend ratio is expected to be 7.6% (based on the 11% discount rate, see the following table). Dividend of the industry grew higher than 27% over the past five years. It reflects the tol road companies dividend payout ratio increases and the growing profit supports toll road stock prices hovering at highs. Therefore, with the expectation of RMB appreciation and booming economic growth in China, the valuation of toll roads remains at a reasonable level. See back of report for disclaimer www.gtjas.com.hk 3
Dividend Discounted Valuation of Toll Road Sector Long-term Dividend Growth Rate to Support the Current Price Discount rate = 10% Discount rate = 11% Discount rate = 12% Target price in 12- month (HKD) Discounted rate to current stock price (%) Sichuan 6.8% 7.9% 8.9% 1.50-9.3 Jiangsu 6.3% 7.4% 8.4% 4.35-4.0 Shenzhen 6.0% 7.0% 8.1% 3.00-5.8 Zhejiang 6.9% 7.9% 8.9% 5.70-4.4 Anhui 6.7% 7.7% 8.7% 3.20-8.6 GZI Transport 7.2% 8.2% 9.2% 2.60-3.8 Weighted Average Market Value 6.6% 7.6% 8.7% -5.0 * Closing Price on 9 Jan 2004 Source: The Company, GTJAS(HK) Investment Rating of Toll Road Stocks We think the price performance of most giant toll road companies such as Jiangsu (0177) and Zheijang way (0576) depends on whether they expand the toll road investment and whether the Transportation Department approves to extend the toll road management period or not. If both companies cannot obtain the approvals or management extension, then it will affect their returns of investment adversely. In particular, Jiangsu way (0576) hovers at the historical highs now. Projected PE for 2004 is 21.4x, 18% higher than the net asset value per share. Their values are obviously higher than the average value for the toll road sector. Therefore, the investment rating of Neutral remains unchanged. Target price in 12-month is HKD4.35 per share. Shenzhen way (0548) will benefit from the significant exceptional gains of disposing national tracks. Projected profit for 2003 may rise 150% in 2003 and PE fall to 7.2x. The traffic flow of three major highways is increasing. It is expected the asset disposals can offset the fall of profit due to the disposals of toll road assets. Currently, projected PE for 2004 and 2005 are 17.8x and 15.3x respectively. Its stock price is 21% discounts to its net asset value per share. The valuation is lower than the average of Chinese automobile. Investment rating for Accumulate is given. Target price in 12-month is HK$3.00. Although the growth rate of traffic flow of Sichuan way (0107) lagged behind the toll roads in coastal areas, the company is expected to benefit from the revaluations of vehicle classification and transportation fees in the Sichuan province. In addition, newly built expressways nearby may stimulate the traffic flow of the toll roads of the company. In particular, the loss of its subsidiary Chengya way is expected to reduce. Currently, the Sichuan Expresway s PE for 2004 is 13.8x and dividend rate is 2.8%. Its valuation more atractive compared with the average of toll road sector. Investors can consider to accumulating this stock when it dips. Target price is HK$1.50. However, investors are advised to note that the liability risk of the company is higher than other companies. In addition, its geographical location is poorer than other toll roads in coastal areas. The stock has lower return investment and the higher volatility of its operating cost in recent years. Therefore, the company s valuation in future may be lower than other large toll road stocks. Investors should put an eye on medium/small toll road operators who have stable income growth and favourable financial position such as Anhui way (0995). It is because the company situated in the central of China. The province is a traffic hub linking with coastal provinces and continental regions. The province is also a production base of basic materials and agricultural products in China. All these factors support the transportation needs remaining at a stable growth. It is estimated Anhui way will benefit from the concentration of production bases. It is expected the net liability ratio of the company in 2004 is only 9%. The transportation cash flow-in per year may be higher than RMB800 milion. The company s financial status is favourable. PEs for 2004 and 2005 are 14.6x and 12.7x respectively. The current valuation is attractive. According to the following table, the valuation and profitability of each toll road per kilometer are highly correlated (the correlated beta is See back of report for disclaimer www.gtjas.com.hk 4
0.96) and they are all close to the straight line. Presently, the valuation of Anhui way is lower than the average and reflects the valuation of the company is too low. Although the geographical location of Anhui way is restricted, the profitability of its toll roads is not as favourable as others in coastal regions. The valuation of the company s each tol road per kilometer is cheaper compared to other tol roads in coastal regions. Therefore, the unfavourable factors have factored on the stock prices. Target price in 12-month is HK$3.20 and investment rating Accumulate is maintained. Market Value of Each Toll Road Per km (mn RMB) 16 14 12 10 8 6 4 2 0 Sichuan Exp Source: The Company, GTJAS (HK) Valuation of Toll Road Stocks GZI Tramsport Average of Toll Roads Anhui Exp Jiangsu Exp Zhejiang Exp Shenzhen Exp R 2 = 0.96 0 0.2 0.4 0.6 0.8 Profit of Each Toll Road Per km (mn RMB) Valuations of Toll Road Stocks Stock Code Price (HK$) Toll Road Stocks Sichuan Jiangsu Shenzhen Zhejiang Expres Anhui GZI Transport Weighted Average of Toll Road Stocks *Closing Price on 9 Jan 04 Source: The Company, GTJAS(HK) Rating PE (x) NAV per share (HK$) Premium Value/(Discount) (%) 02 03 04 03 04 03 04 04 DPS (RMB) Div ratio (%) 0107 1.360 Accumulate 17.5 15.1 13.8 1.57 1.66 (13.1) (18.2) 0.040 2.8 0177 4.175 Neutral 26.1 21.3 17.7 3.92 4.36 6.5 (4.2) 0.155 3.5 0548 2.825 Accumulate 18.1 7.2 17.8 3.56 3.82 (20.7) (26.1) 0.120 4.0 0576 5.450 Neutral 28.2 24.8 21.4 4.61 4.75 18.3 14.7 0.160 2.8 0995 2.925 Accumulate 14.2 16.3 14.6 3.54 3.61 (17.4) (19.0) 0.090 2.9 1052 2.500 Accumulate 16.6 12.3 10.8 2.89 3.10 (13.5) (19.3) 0.074 2.8 Neutral 24.3 20.1 18.4 4.5% (1.7) 3.2 See back of report for disclaimer www.gtjas.com.hk 5
Rating Definition he Benchmark: Hong Kong Hang Seng Index Time Horizon: 6 to 18 months ating Relative Performance Buy >15% Accumulate 5% to 15% Neutral -5% to 5% Reduce -5% to 15% Sell <-15% Research Report Disclaimers Editor: Christine Yim This report is only subject to GTJAS (HK) Ltd. Co. be circulated to specified clients and other professionals for reference information. Neither the information nor any opinions contained in this report constitutes a solicitation or offer by the Group to buy or sell. The GTJAS (HK) Ltd. Co., fellow subsidiaries, associates or other affiliates (the "Group") may become placing agent, lead manger, sponsor or underwriter or invest on any specific stock. This report may not be reproduced, distributed or circulated to other specified viewership, otherwise, it may violate certain of Securities Ordinances. Please also note that in relation to information provided, by GTJAS (HK) Ltd. Co. (GTJAS), we endeavour to ensure the accuracy and reliability of the information provided but do not guarantee its accuracy or reliability and accept no liability (whether in tort or contract or otherwise) for any loss or damage arising from any inaccuracies or omissions. The report may contain some subjective and prospective assumptions and judgements on future politics and economy without certainties. Investors should thoroughly understand the purposes and risks of equities and derivatives investment therein. Before making the investment, if necessary, investors should consult the professionals and then make a prudential investment decision. See back of report for disclaimer www.gtjas.com.hk 6