The rating on SZIH reflects the company's 'bbb-' stand-alone credit profile (SACP) and our opinion that there is a "moderately high" likelihood that the Shenzhen municipal government will provide sufficient and timely extraordinary support to the company in the event of financial distress.
SZIH's SACP reflects our assessment of the company's "satisfactory" business risk profile and "significant" financial risk profile.
In our opinion, SZIH's business risk profile benefits from: (1) the company's stable cash flow from its toll road portfolio; (2) its good quality assets; (3) its strong position in its home market; and (4) ongoing support from the Shenzhen municipal government.
We expect SZIH's toll roads, which are primarily located in Shenzhen, to maintain stable traffic growth over the next two years. Most of these roads have an established operating record. Traffic on the company's longest toll road is steadily growing due to its competitive advantage in terms of cost, safety, and better road condition. SZIH's toll road network in Shenzhen is strategically positioned: it links Yantian port, the largest port in Guangdong province, to Shenzhen's sole airport and the highway to Hong Kong. Guangdong's continued economic growth, high car ownership, and improving road network also support SZIH's toll road business.
SZIH's well-located logistics property assets provide stability to its business risk profile. The company's logistic parks serve important infrastructure facilities and provide value-added services that help keep tenant occupancy rates high.
The lack of a transparent cost pass-through mechanism in setting toll rates and a potential change in toll road policy in China temper SZIH's business risk profile. Any adverse change in the concession agreements, such as a decrease in toll rates, is likely to dent SZIH's profit margin. Nevertheless, our expectations of stable traffic volume growth and Shenzhen municipal government's strong support to SZIH temper the regulatory risk, in our view.
SZIH has inherent structural subordination of cash flows from its operating assets. Its 50.89%-owned subsidiary, Shenzhen Expressway (SZE; not rated), and other project companies in China operate the bulk of the toll roads. We assess the capital structure of Shenzhen Airlines (in which SZIH owns 49%) as highly leveraged and believe that the company has a much weaker credit profile than SZIH. In our view, the SZIH management's commitment to refrain from making further capital injections into the airline supports our rating on the company.
We believe SZIH's stable cash flows from operations are likely to offset its aggressive financial metrics for 2012. We project the company's debt-to-EBITDA ratio at more than 4x and ratio of funds from operations (FFO) to debt at less than 18% for the year. Our base-case assumption includes flat toll rates and an average 5% increase in traffic volume in 2012. The company's expansion in the logistics business and major repairs on three toll roads are likely to drive capital expenditure. We anticipate some balance sheet deleveraging from 2013 onwards. We estimate SZIH's FFO-to-debt ratio to improve to close to 20% by the end of 2013. The company's improving cash flow from its toll roads and enlarged logistic operations support our view.
We consider SZIH to be a government-related entity (GRE). In accordance with our criteria for GREs, our view of the "moderately high" likelihood of extraordinary support from the Shenzhen municipal government is based on the following SZIH characteristics:
-- "Strong" link with the municipal government. Although the government's stake is slightly less than 50%, we believe it is able to exert strong influence on the company's financial and operational strategy through the nomination of all executive directors.
-- "Important" role to the government. The municipal government considers SZIH a state-owned enterprise with strategic importance to the city. It has set up SZIH as its sole logistic and infrastructure investment platform.
We assess the credit profile of the Shenzhen municipal government to be stronger than the SACP of SZIH. This reflects Shenzhen's very strong local economy, the government's healthy financial profile with good budgetary performance and low debt, and strong liquidity position. The government's large contingent liabilities stemming from the significant off-budget activities of its state-owned enterprises, constrained fiscal flexibility, and the intergovernmental framework partly offset these strengths.
The issue rating on SZIH's proposed senior unsecured bonds reflects our opinion of the bonds' structural subordination risk compared with priority senior debt at the operating company level.
We assess SZIH's liquidity to be "adequate" under our criteria. The company's stable cash flows from toll road operations and its discretionary capital expenditures for expansion of the logistic business support our view.
Our liquidity assessment is based on the following factors and assumptions:
-- We expect the company's liquidity sources to exceed its uses by more than 1.2x over the next 12 months.
-- Net liquidity sources should remain positive and the company will still be in compliance with financial covenants in its debt documents even if EBITDA declines 15%.
-- Near-term liquidity sources include a cash balance of Hong Kong dollar (HK$) 3,724 million as of Dec. 31, 2011, our forecast of cash flow from operations of about HK$2.6 billion, and committed bank facilities.
-- Near-term liquidity uses include 2012 debt maturities of about HK$1,412 million, committed capital expenditure, and estimated annual dividend payouts of about HK$700 million. We believe the company has greater flexibility on capital expenditure for expansion of the logistic business than for maintenance of toll roads.
The stable rating outlook reflects our view that SZIH will continue to benefit from the steady traffic growth of its toll road portfolio while expanding its logistic business. We expect the company to maintain good operating profitability and positive free cash flow over the next two years. SZIH's well-located toll roads and logistic assets are likely to provide resilience to the group's performance even if China's economy and trade weaken.
We could raise the ratings on SZIH if the company's financial performance improves materially. This could happen if the company: (1) generates strong traffic revenue, with traffic volume well above our base-case assumption of 5% annual growth; (2) expands its logistic business through good quality assets, and (3) maintains a positive free cash flow position to keep leverage in check. A sustainable strengthening of its FFO to debt ratio to about 30% or more would indicate such improvement. In a less likely scenario, we could upgrade SZIH if we believe that the likelihood of the company receiving extraordinary government support has improved.
Conversely, we could lower the ratings on SZIH if the company's financial strength weakens such that its ratio of FFO to debt declines to less than 15% on a sustained basis. This could happen if: (1) the average traffic volume of the company's toll roads portfolio drops by more than 10% from 2011 levels; (2) toll rates decrease significantly or concession arrangements change unfavorably; (3) operating margins decline significantly because of a substantial increase of operating costs and expenses, or a material underperformance of the logistic business due to execution risk in business expansion or a decline in rentals; or (4) the company has a significant capital expenditure overrun or engages in aggressive and large debt-funded new investments. We could also downgrade SZIH if it provides further financial support to Shenzhen Airlines or the likelihood of extraordinary government support declines, in our opinion.
Related Criteria And Research
-- Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011
-- General Criteria: Rating Government-Related Entities: Methodology And Assumptions, Dec. 9, 2010
-- Criteria Methodology: Business Risk/Financial Risk Matrix Expanded, May 27, 2009
-- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008
Shenzhen International Holdings Ltd.
Corporate Credit Rating BBB/Stable/--
Senior Unsecured BBB-