China's toll road sector is facing two lanes of trouble. The new coronavirus (COVID-19) outbreak caused a traffic slump and also led to an unprecedented moratorium on toll fees for vehicles on all roads. S&P Global Ratings believes this drastic policy will lead to major revenue losses in the sector.

We estimate the toll road sector as a whole may lose Chinese renminbi (RMB) 270 billion (US$38 billion) or more in 2020. Toll-road companies that operate along commercial lines are more vulnerable to rating downgrades. This is because these companies, some of which are publicly listed, generate a material portion of their operating cash flow for servicing debt from toll collections. Provincial highway groups, which are highly leveraged, tend to have more reliance on government and bank support to maintain their debt-financed business model. Bank lenders are likely, in our view, to show forbearance to the sector until the health emergency subsides.

We anticipate a strong traffic recovery following the stabilization of the virus outbreak in China, a resumption in economic activities, and the stimulus effect of free highway travel. Traffic volumes and growth should return to normal in 2021. We also expect the government to unveil measures to address short-term liquidity stress and introduce long-term compensation for the sector.

We have recently taken rating actions on a few Chinese toll road companies. These actions reflect our opinions of their different asset exposure, financial headroom, liquidity position, and potential external support. This FAQ is intended to address some of the key points we have considered in taking these rating actions--or not taking action, as the case may be.

Frequently Asked Questions

What's the background on the policy decision to suspend all toll collection?

We believe the strategy is aimed at speeding economic recovery after a standstill in activity due to measures to contain the virus spread. As lockdowns, travel bans, and quarantines ease up in China, toll-free travel will reduce logistics and transportation costs, which should facilitate a resumption in industrial production. At the same time, vehicle travel also can help reduce the risks of a virus infection as people flows and economy activity resume. Hence the toll-free policy aims to incentivize individuals to drive instead of using public transport.

Toll-free periods are not new for China, though they usually apply largely to passenger vehicles. In recent years, passenger-car traffic has expanded faster than that of other vehicles due to increasing car ownership and a robust middle-class appetite for travel and tourism. China's central government often implements such moratoriums during national holidays as public welfare measures, also to boost tourism and relieve pressure on other means of transport in these peak-usage periods. Since September 2012, China has granted toll-free periods for passenger cars during four national holidays annually, totaling 20-21 days every year.

In 2020, the toll-free period for passenger cars during the Lunar New Year was originally set from Jan. 24-30. Amid the health emergency, it was extended twice to Feb. 8. On Feb. 17, the moratorium was expanded to all vehicles until the epidemic is completely contained.

So far, the toll exemptions seem very effective. On March 13, daily traffic on all highways grew to 30.21 million vehicles, 15.7% higher than on the same day in 2019. In contrast, daily highway traffic on Feb. 16, the day before the policy implementation, was merely 5.42 million. Roads are a more important mode of transportation than rail or air in China, accounting for about 75% of passenger and freight transportation. China's highway network is the longest in the world, totaling 142,600 kilometers in 2018, and expanding at cumulative average annual growth rate of 8.5% during 2010-2018 (see chart 1). Highways account for 82% of all toll roads in China. The rest include toll bridges and toll tunnels, and class I and class II roads of lower grades which will be gradually phased out of toll collection.

Chart 1

What's the financial health situation of the provincial highway groups that own most of China's toll-roads?

In general, weak. Most provincial highway groups prioritize development goals over financial prudence. They have been able to build up debt despite high leverage and strained liquidity due to their strategic importance.

In China, provincial governments lead the investments in highway construction. They mostly do this by setting up enterprise groups to develop highways. These enterprises have two models for operating tolls:

Government toll roads:   Some provincial highway groups represent the government to construct and operate highways; as such, revenue and expenses are part of the government budget and road-related loans would ultimately be borne by the government. For example, Gansu Provincial Highway Aviation Tourism Investment Group Co. Ltd. operates all government toll roads in Gansu.

Franchise toll roads:   In other cases, the provincial highway groups operate toll roads over 25-30 year concession periods and their debt is categorized as corporate debt. Some governments have grouped together and spun off the best franchise assets for separate company listing; these entities operate on more commercial terms.

As of end 2018, government highways made up 53% of highway mileage, compared with 47% from franchise highways.

Despite the different approaches, all the highways represent important and sizable transportation-infrastructure assets for each province.

Are tolls the dominant source of funding for China's highway buildout?

No. Provincial highway groups borrow heavily to fund the significant capital spending needed to meet highway development goals set by their governments. On average, about 70% of highway investments in China are debt financed and total outstanding debt of the sector amounted to RMB5.36 trillion at end-2018 (see chart 2). More than 80% of this debt is in the form of long-term amortized bank loans. Most credit lines for the highway groups are project-related, with fewer set up as working capital facilities.

Chart 2

On an aggregate basis, the deficit is widening between toll revenue and toll-road expenses. These expenses are mostly debt-related: principal and interest payments account for 80% of the total (see chart 3). Toll revenue of highways totaled RMB516 billion in 2018, compared with scheduled debt payments of RMB726 billion and other expenses of RMB176 billion including maintenance, operating expenses, taxes etc. Some provincial highway groups highly rely on new borrowings to refinance maturing debt and pay interest expenses.

In addition, provincial governments have used their highway groups to invest in other transportation infrastructure, such as regional railways. These capital-intensive and non-profitable new investments are further weakening the financial health of these companies.

However, some of the sector companies we rate tend to be more commercially minded, and some of them rely heavily on toll revenue to pay debt and expenses.

How will highly leveraged provincial highway groups manage this year's revenue loss and liquidity stress?

In our view, bank support is key to keep them afloat. Given most financiers are state-owned commercial and policy banks, we expect banks will likely be guided by regulators to postpone the payment of debt interest and principal during the toll-moratorium period. Nevertheless, these companies still need to manage the payment risk of their bonds, especially short-term commercial paper, and other non-conventional financing such as trust loans or insurance funds. These nonbank financings usually have hard payment deadlines and the lenders are generally less flexible.

We believe some highly leveraged provincial highway groups may have to tackle rising leverage and cash flow deficits through debt restructuring. There is some precedent to this approach. For example, in 2019, Shanxi Transportation Holdings Group Co. Ltd. was able to restructure its RMB260 billion debt. A bank consortium led by China Development Bank agreed to extend new loans with longer maturity and lower interests to swap its existing debt. To repay those loans, which are secured by toll collections, the Shanxi government may have to raise toll rates to improve revenue.

Chart 3

The credit profiles of listed toll-road companies are affected more than the sector average. Why is that?

Their financial metrics are more sensitive. Publicly listed toll road companies (listcos) tend to have stronger financials and better asset quality than the provincial highway groups. The stand-alone credit profiles of listcos are higher, and some of these issuers are investment-grade. However, greater commercialization means the listcos are more disrupted by the moratorium on tolls.

While most listed toll road companies are subsidiaries of a provincial highway groups, they have a more market-based business model than that of their non-listed peers. The provincial owners raise capital for new investments by putting their best assets, i.e., those with stronger traffic, in the listcos. These listcos generate strong cash flow from a relatively small but mature toll road portfolio, and have a smaller debt amount outstanding. These characteristics lead to healthier leverage ratios and favorable funding costs. Among the listed toll road operators we rate, their financial risk profiles are assessed at intermediate--the third strongest of our six categories. In contrast, the non-listed companies have much higher financial leverage.

Uncertainty is also on the rise for other reasons. As the operating life of their portfolios decline, many companies started to diversify into other sectors such as environmental service, property development, or financial service. Such diversification can increase both leverage and business volatility.

How long will the toll-free period last, and what's the cost to sector players?

China says tolls will be suspended on all roads, and for all vehicle types, until the COVID-19 outbreak is contained. Our base case assumes the moratorium will remain in place until mid-2020. We estimate the toll road sector as a whole may lose at least RMB 270 billion-RMB280 billion in 2020.

For the highway companies we rate, we see toll revenue shrinking an average of 50% in 2020. This takes into account our assumption of the special moratorium, and the impact of other existing toll-free policies.

The current conditions create significant financial strain for rated toll-road companies. They have to continue normal service on highways, pay staff and other operating expenses, and keep minimum maintenance. They still have to service debt--though we expect some forbearance from the banking system. It is tougher on the listcos, as mentioned above, because they rely to a greater extent on tolls for operating cash flow. The credit impact is even more acute for the companies with limited financial headroom due to recent acquisitions or large capital expenditures.

We also note that most of the downgrade pressure will come from plunging cash flow in 2020 breaching downgrade triggers, rather than liquidity stress. Four out of the five toll-road operators we rate maintain sufficient cash balances to cover short-term payment obligations over the next six to 12 months.

Our base case assumes traffic will gradually pick up, normalize after the end of epidemic, and see a rebound in 2021. Traffic is currently growing fast for the listcos, due to good location of their assets, though this of course is partly attributable to the incentive of toll waivers.

Table 1

Table 2

Why has S&P Global Ratings taken actions on some but not all rated toll road operators?

The credit impact varies, depending on companies' different asset exposure, financial headroom, liquidity position, and potential for external support. See below a summary:

• Yuexiu Transport Infrastructure Ltd.(YXT): We revised our rating outlook on YXT to negative from stable on Feb. 24, 2020. Even before the outbreak, the rating buffer was very thin, as measured by YXT's leverage, due to large debt-funded acquisitions of three toll roads in November 2019. Moreover, over 40% of the company's toll revenue comes from highways located in Hubei province, the center of the outbreak and China's worst-hit province. Even after the ban on tolls is lifted, traffic in Hubei province is likely to take longer to recover than in other regions in China. Among peers, YXT faces the most downward pressure if toll revenue cannot recover quickly and robustly in the second half of 2020.
• Shenzhen Expressway Co. Ltd. (SZE): We affirmed our rating on March 6, 2020. We expect SZE to remain a core subsidiary of its parent--Shenzhen International Holdings Ltd. (SZIH), and SZE's main rating driver is the SZIH group credit profile. In our view, SZE has sufficient financial flexibility to absorb the slump in its toll revenue. This includes a planned HK$3 billion share placements. SZE's key metrics will likely deteriorate in 2020 but this will be temporary, with a rebound in 2021 to well above the existing downgrade trigger on its stand-alone credit profile.
• Shenzhen International Holdings Ltd. (SZIH): On March 6, 2020, we affirmed our issuer credit rating on SZIH. But we revised the stand-alone credit profile to 'bb+' from 'bbb-' to reflect our expectation of increasing volatility in financial performance. The volatility stems from a fast-growing contribution from the non-toll road segments on top of the stress at SZE. We continue to expect SZIH to have a moderately high likelihood of receiving extraordinary support from the Shenzhen government in the case of financial distress.
• Gansu Provincial Highway Aviation Tourism Investment Group Co. Ltd.: We affirmed our rating on Gansu Highway on Feb. 26, 2020, because we believe the company's large cash balance and strong government and bank support will provide a buffer against lost toll revenue in 2020. Gansu Highway's primary rating driver is the credit profile of Gansu provincial government, given we expect an almost certain likelihood of extraordinary government support if needed. The company's good access to funding allows it tap funds on short-term schedules, often six months ahead of expected cash outlay for debt payment. This is reflected on its sizable cash balance and bank deposits at each year end. Strong bank support provides the lifeline for sustaining high capital spending and debt servicing despite weak revenue generation.
• Shanxi Road & Bridge Construction Group Co. Ltd.: We assess the company as having a weak stand-alone credit profile at 'b-' and less-than-adequate liquidity position. Its core business remains road engineering & construction (E&C), and it merely operates a small toll road portfolio. The 'BB-' issuer credit rating benefits from the support of its state-owned parent group, as well as bank support due to its state ownership background and the most important E&C company in the Shanxi province.

Table 3

Will the government compensate the highway operators for losses suffered by the moratorium?

Nothing concrete has been offered yet. At this juncture, the public interest is taking priority over the interests of toll-road companies and their stakeholders. However, in announcing the broad-based moratorium in mid-February, the government did say it would contemplate measures to protect the toll road companies and their stakeholders, including creditors. While the sector is dominated by state-owned companies, some are listed and have a broader base of shareholders. Reports indicate that the State Council is coordinating with relevant ministries to unveil some form of support.

We believe cash compensation is less likely because this option would add to fiscal strain at a time when government budgets are already weakened by the epidemic and related containment measures. Sector companies are more likely to be compensated by non-cash methods. In particular, they could be granted extensions of concession periods for toll roads. In our current rating assessment of toll road companies, we have not factored in any such support measures unless they have been actually implemented.

Meanwhile, targeted short-term measures could help ease financial strain, given their high leverage and interest expenses. We believe banks have been urged to consider rolling over maturing loans , delaying interest payments, and granting working capital loans at favorable interest rates. Some toll-road companies issued or plan to issue "anti-epidemic" short-term bonds for refinancing or working capital purposes. The regulator is supporting the issuance of these special bonds by providing fast approval and execution convenience to eligible applicants, and the anti-epidemic bonds have so far been well received by the market and priced at relatively low yields.

Does this toll moratorium affect S&P Global Ratings view on China's regulation risk?

We view this broad, open-ended toll moratorium as an unprecedented and temporary policy measure put in place to combat very special circumstances. While its abrupt roll-out points to the urgency of China's economic hit from the COVID-19 outbreak, it also reflects the intrinsic regulatory and policy risk that Chinese toll road operators face. We factor in regulation risk into our assessment of an issuer's competitive advantage and its business risk profiles.

In China, inflexible toll rate setting and lagged adjustment have resulted in low returns for many new highway projects. The schedule of toll rates is set by each provincial transportation regulator and applied to all highways of same vehicle type in the same province. While there are some exceptions, with higher tolls to match higher investment costs per kilometer, these are few. Adjustment of toll rates is neither timely nor automatic to reflect changing operating costs or to ensure investment returns. Any proposed adjustments are normally subject to a lengthy process of public hearings, in which affordability of end-users is an important consideration.

Toll-road operators have never been compensated for revenue losses, reduced returns due to existing toll-free policies (see chart 4). In 2018, revenue losses from waived tolls amounted to RMB87.2 billion, representing 14.4% of the aggregate of reported revenue and lost revenue.

Chart 4

The regulator has long been in consultation with the industry on potential compensation for the revenue losses--including via extended concession periods on toll operations. In our view, this year's extended and total moratorium may accelerate compensation decision-making process. Extension of concessions would extend future cash flows and portfolio length, without directly straining government budgets.

If China were move to a more transparent regulation framework on toll road investment and operation, it would in return benefit toll operators by facilitating healthier business models and predictable cash flows, and hence be positive to their credit profiles.

Related Research And Criteria

Related Research

• Shenzhen Expressway 'BBB' Rating Affirmed With Stable Outlook; Toll Revenue Drop Will Be Temporary, March 6, 2020
• Shenzhen International Holdings Ltd. 'BBB' Rating Affirmed; Outlook Stable; Stand-Alone Credit Profile Lowered To 'bb+', March 6, 2020
• Gansu Highway 'BBB' Ratings Affirmed; Outlook Stable, Feb. 26, 2020
• Yuexiu Transport Infrastructure Outlook Revised To Negative On Sharp Revenue Decline; 'BBB-' Rating Affirmed, Feb. 24, 2020
• Sudden Policy Change In China Hits Toll-Road Operators' Liquidity, Feb 18, 2020
• Coronavirus Will Take A Big Toll On China's Transport Operators, Feb. 4, 2020
• Shanxi Road & Bridge Construction Group Co. Ltd., Nov. 15, 2019

Related Criteria

• Key Credit Factors For The Transportation Infrastructure Industry, Nov. 20, 2013