S&P: MTR Corp. Ltd. Stand-Alone Credit Profile Lowered On Rising Leverage; 'AAA/A-1+' Ratings Affirmed; Outlook Negative
We also affirmed our 'AAA' and 'cnAAA' long-term issue rating on the senior unsecured notes that MTR and its subsidiary MTR Corp. (C. I.) Ltd. issued. MTR guarantees the notes its subsidiary issued.
We affirmed the rating because we continue to expect MTR to have an almost certain likelihood of receiving extraordinary support from the Hong Kong government. We believe the government's commitment and capacity to support MTR remain solid because the company undertakes an important public policy role for the Hong Kong Special Administrative Region (HKSAR: AAA/Negative/A-1+; cnAAA/cnA-1+).
"We revised our assessment of MTR's stand-alone credit profile to 'a+' from 'aa-' to reflect our expectation that the company's leverage will deteriorate over the next two to three years," said S&P Global Ratings credit analyst Joseph Lin.
We attribute MTR's weakening financial strength to: (1) the company's elevated capital expenditure program, including expansion in mainland China and other overseas projects, property development-related initiatives, as well as Rail Gen 2.0--a collection of projects to upgrade the signaling systems and to retrofit certain rail infrastructure; and (2) special dividends of about Hong Kong dollar (HK$) 25.9 billion that is payable over 2016 and 2017. The company paid HK$12.94 billion of special dividends in July 2016, and it will pay the second installment in the second half of 2017.
Consequently, we expect MTR's ratio of funds from operations (FFO) to debt to decrease to 20%-22% over the next two years, from 57.2% at year-end 2015.
We expect MTR's market position as the sole railway operator in Hong Kong to continue to underpin its business risk profile, which is the key driver of the stand-alone credit profile (SACP). We anticipate MTR's Hong Kong transportation operation and station commercial business will grow steadily. MTR will maintain a high barrier to entry due to its exclusive role as the sole subway and railway service provider in HKSAR. The company's strong operating track record, robust brand awareness, and the capital intensive nature of the business should also help keep competitors away. The company has businesses in Hong Kong, mainland China, the U. K., Australia, and Sweden.
We expect the profitability of MTR's recurrent businesses (transportation, station commercial, and property rental and management) to remain stable over the next 12-24 months. We estimate the company's overall EBITDA margin to be 36.5%-37.5%, slightly lower than in previous years because of lower profits from property development.
The arbitration of the cost overrun upon MTR's completion of the express rail link project (XRL) (the 26-kilometer Hong Kong section of the Guangzhou-Shenzhen-Hong Kong Express rail link) and an early review of its fare adjustment mechanism could affect our financial projections for the company for the next two to three years.
"The negative outlook on MTR reflects the rating outlook on HKSAR," said Mr. Lin. "The ratings on both entities will move in tandem. We expect MTR to continue to have an almost certain likelihood of extraordinary support from the government in the event of financial distress."
We would downgrade MTR if we lower the rating on HKSAR. We may also lower the rating on the company if we believe the Hong Kong government's commitment to provide support to MTR has weakened. While we believe such a scenario is unlikely, weakened management control or a significant reduction in the government's ownership would indicate weaker government commitment.
We could lower MTR's SACP if we believe the company's business risk profile has weakened, possibly due to events such as material adverse changes in the fare adjustment mechanism and other regulations. We could also lower the SACP if the company's financial strength deteriorates such that the FFO-to-debt ratio declines to below 18%.
We would revise the outlook to stable following the same rating action on HKSAR.
We would consider raising the SACP if we have the confidence that the company would maintain the FFO-to-debt ratio above 25% on a sustained basis.