OREANDA-NEWS. Fitch Ratings has affirmed Hong Kong-based rail transit network operator MTR Corporation Ltd's (MTRC) Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDR) at 'AA+'. The Outlook is Stable. The agency has also affirmed MTRC's Short-Term Foreign-Currency IDR at 'F1+' and senior unsecured rating at 'AA+'.

MTRC's 'AA+' ratings are equalised with its major shareholder (75.71%), the Hong Kong government (AA+/Stable), because of their strong operational and strategic ties, as per Fitch's Parent and Subsidiary Linkage methodology. Fitch does not envisage any significant adverse change in MTRC's fundamentals and relationships with the state over the foreseeable future, which underpins the Stable Outlook for the rating.

MTRC has historically maintained a strong financial profile. However, cash outflows related to the completion of the Guangzhou-Shenzhen-Hong Kong Express Rail Link (XRL) project will weaken its credit metrics in the medium term, from very robust levels maintained in the past, reducing its headroom under its standalone credit assessment of 'A+'.

KEY RATING DRIVERS

City-Wide Network: MTRC operates a mainly rail-based transportation system in Hong Kong, comprising domestic and cross-boundary services, the Airport Express railway and a light rail system. The company's network covers all the key commercial and strategic locations in Hong Kong and had a 48.5% share of Hong Kong's public transport market in the first five months of 2015. We expect MTRC's market share to continue to rise due to a gradual increase in network coverage from the completion of new railways; four new lines are scheduled to start operation from 2H16 to 2021.

Strategic Importance to Government: MTRC's extensive network coverage makes it important to the government's objective of making the rail transit network the backbone of the domestic transportation system. The Hong Kong government is the largest shareholder with a 75.71% stake in MTRC, and three senior government officials sit on MTRC's board.

Tangible Support from Government: The government has repeatedly demonstrated its ability and willingness to provide tangible financial support to the company to maintain MTRC's financial strength. Such support has in the past come from property development rights, dividend waivers or capital grants. In addition, the government will bear the construction costs for some of the new projects, such as the Shatin-Central Link (expected completion in 2019-2021) and Express Rail Link (scheduled completion in 3Q18), with MTRC likely to be the operator of the two railways under a service-concession model.

Resilient Property Businesses: Rentals from MTRC's well-located investment properties, such as shopping malls, and from shops within its stations remain strong despite slowing retail sales in Hong Kong. This provides stable cash flows to the company. Also, the completion of MTRC's property development projects (expected completion dates range from 2017 to 2022) will support capital expenditure on construction of new railways.

XRL-Related Payments, Potential Liabilities: The total cost of the XRL project has been revised up to HKD84.42bn, from HKD65bn previously. MTRC only acts as the project manager, and possibly operator of the expressway line when completed. However, as per the agreement MTRC entered into with the HKSAR government in November 2015, the company will pay a special dividend totalling HKD25.76bn, which will be made over two equal instalments in 2H16 and 2H17, subject to approval from independent (non-government) shareholders at an EGM on 1 February 2016. The XRL agreement is also subject to approval from the Legislative Council for the HKSAR government's additional funding obligations. The XRL's increased budget can be covered by this special dividend, as the Hong Kong government being a major shareholder, would receive around HKD19.51bn. However, the agreement also introduces some additional contingencies for MTRC if the total costs of the project escalate further.

Credit Metrics to Weaken: Fitch now expects MTRC's financial leverage as measured by FFO-adjusted net leverage to increase to around 3.1x in 2017 (2014:0.7x) and its FFO fixed-charge coverage to weaken to around 5.0x (2014: around 8.0x), after factoring in additional debt to fund the special dividend payments in 2016 and 2017. The deterioration in its credit metrics is counterbalanced by MTRC's strong cash generation from its stable rail operations in Hong Kong and its quality property operations and assets in the city, leaving its standalone credit profile at 'A+', albeit with a much lower buffer than previously. We may consider lowering MTRC's standalone credit assessment if its credit metrics weaken more than expected on a sustained basis.

Insignificant Overseas Operations: The company continues to expand overseas, but the operations are low risk because most of them are operated under joint ventures and they contributed to only 3% of 1H15 EBITDA. We do not expect overseas operations to be a significant contributor to earnings.

KEY ASSUMPTIONS

Fitch's key assumptions within the rating case for MTRC include:
- Revenue growth is driven mainly by improving patronage from opening of new railways (South Island Line in end-2016 and Kwun Tong Line Extension in 3Q/4Q16) and fare growth, which is linked to inflation.
- Profit from sale of Hemera (LOHAS Park Package 3) is included in our 2015 forecast. We assume profit from the sale of Tiara in Shenzhen will be booked in 2016-17.
- MTRC's total capex to reach HKD50.7bn for the three years from 2015 to 2017.
- Special dividend of HKD25.76bn (in relation to the XRL agreement), which will be paid in two equal instalments in 2016 and 2017.

RATING SENSITIVITIES

Positive: Future developments that may, individually or collectively, lead to positive rating action include:
- Positive rating action on the Hong Kong sovereign, provided the linkages remain strong and intact

Negative: Future developments that may, individually or collectively, lead to negative rating action include:
- Negative rating action on the Hong Kong sovereign
- Evidence of diminishing support from or weakening ties with the Hong Kong government