Sector Review:

How China's Metros Could Start To

Pay Their Way
Primary Credit Analyst:
Gloria Lu, CFA, FRM, Hong Kong (852) 2533-3596; gloria.lu@standardandpoors.com
Secondary Contacts:
Han Yan, Hong Kong (852) 25333505; han.yan@standardandpoors.com
Lawrence Lu, CFA, Hong Kong (852) 2533-3517; law.lu@standardandpoors.com
Table Of Contents
Government Support Will Remain Key
Funding Sources Are Widening
Why Fares May Start To Rise
Property Development Isn't A Panacea
Further Down The Line
Related Criteria And Research
WWW.STANDARDANDPOORS.COM/RATINGSDIRECT JUNE 11, 2014 1
1331246 | 301447691
Sector Review:
How China's Metros Could Start To Pay Their
Way
China's biggest metro is taking a new funding route. In March 2014, Beijing Infrastructure Investment Co. Ltd. (BII)
became the first Chinese subway company to tap the overseas bond market, with the issuance of US$300 million in
senior unsecured notes. The Beijing metro operator is also the first to partner with private investors for an expansion
project. Other metros may now follow. Local governments, which own railways assets through infrastructure
investment companies, have bankrolled the massive increase in networks in recent years and continue to subsidize the
operators' losses. But Standard & Poor's Ratings Services believes the burden may become increasingly unsustainable,
given the vast scale of works and the governments' already-high indebtedness.
Broader long-term funding is vital. Beijing's metro is undergoing rapid expansion to reduce traffic congestion and
alleviate chronic pollution. This year, the city will add 60 kilometers of track and a further 440 km over the next seven
years, almost doubling the network. Similar expansion is occurring throughout Chinese cities as urbanization increases.
By 2020, the central government targets that 6,000 km of metro lines will have been built. This follows decades of
chronic underinvestment. Beijing has just 200 meters of track for every 10,000 people, compared with 500 meters in
New York and 300 meters in Singapore. But scaling-up will be costly. We estimate that new metro lines in China will
require investment of Chinese renminbi (RMB) 2.0 trillion-RMB2.5 trillion (US$320 billion-US$400 billion) from
2014-2020.
Overview
Metro systems in China are undergoing massive expansion, in line with the central government's policy aim to
develop infrastructure to support economic growth.
Local governments are finding it increasingly challenging to meet the steep investment costs, and may need to
consider allowing fares to rise from their currently low levels.
The Beijing metro operator was the first in China to tap the overseas bond market for funds and to adopt a
public-private participation business model, and more companies may follow suit.
The creditworthiness of local governments will continue to underpin the credit profiles of metro operators.
Increasing private-public participation in projects and better utilizing opportunities for property development could
help metro companies diversify their funding and revenue bases. In turn, that would reduce the strain on municipal
coffers and staunch escalating operating losses. Raising uncommercial fares would also alleviate a major constraint on
profitability. Such steps would improve the stand-alone credit profiles of the metro operators.
WWW.STANDARDANDPOORS.COM/RATINGSDIRECT JUNE 11, 2014 2
1331246 | 301447691
Chart 1
Government Support Will Remain Key
Fiscal support from the Beijing government, which owns the metro operator, underpins Standard & Poor's rating on
BII (A+/Stable/--; cnAAA/--). The government funds the metro's construction and cushions the company's operating
losses through annual subsidies. Beijing's strong creditworthiness facilitated BII's debut bond issue in March 2014.
We see an almost certain likelihood of extraordinary government support for BII because the company plays a critical
role as the municipal government's sole company involved in rail transport investment and financing. BII provides an
essential public service that the private sector couldn't easily undertake. The company also plays a vital role in
executing the long-term urban transport development plan of China's capital city, and achieving the government's
social and economic objectives.
In our view, the Beijing government is highly unlikely to divest its full ownership in BII. The government plays a
decisive role in BII's business strategy, operational oversight, and project financing. The government in effect
consolidates most of BII's debt, and includes operating subsidies and project funds as part of the government fiscal
budget. According to a recent audit on the Beijing government, the rail transport-related debt that the municipality
WWW.STANDARDANDPOORS.COM/RATINGSDIRECT JUNE 11, 2014 3
1331246 | 301447691
Sector Review: How China's Metros Could Start To Pay Their Way
supported amounted to RMB151.9 billion by June 2013, about 20% of total government debt.
Capital injections will continue for operators
We forecast that local governments will inject 30%-40% of the capital that the metro operators will need to invest in
their networks by 2015. Furthermore, local governments may provide implicit debt guarantees for construction. Given
the importance of such support, the creditworthiness of local governments will remain a predominant factor in our
ratings on metro companies.
The key risk to ratings is that the governments' support for the metro companies may start to wane as they attempt to
rein back their soaring debt levels. To determine the likelihood of extraordinary support for individual companies,
however, we require sufficient financial information on the governments, and that isn't always forthcoming.
Chart 2
Funding Sources Are Widening
BII has a financing model that other operatorsand their debt-laden governmentsmay be keen to pursue. Overseas
funding has helped BII to diversify its investor base and reduce financing costs since U.S. dollar funds have lower costs
than domestic funds. Operators like BII may also look to broaden their financing channels through the use of trust
WWW.STANDARDANDPOORS.COM/RATINGSDIRECT JUNE 11, 2014 4
1331246 | 301447691
Sector Review: How China's Metros Could Start To Pay Their Way
funds and domestic bonds. However, government capital injections and bank borrowings will remain the main funding
sources for metro companies for the long term, given the large size and the long tenor of such financing.
Metro developers in China are likely to increasingly adopt private-public participation (PPP) models to fund projects
over the next few years. Line 4 of the Beijing metro was the first in China to be funded this way just over four years
ago. BII partnered with Hong Kong's highly profitable metro operator, MTR Corp. Ltd. (MTRC), for the project. Beijing
MTR Corp., a consortium that MTRC leads, invested RMB4.6 billion in the line, which it also operates. The Hong Kong
company brings not only long-term funding to BII but a wealth of operational and management expertise. In May
2014, the government announced 80 infrastructure projects to attract "social capital" on a PPP basis, including line 16
of the Beijing metro and line 6 of the Shenzhen Metro.
In our opinion, increasing the amount of private capital in metro projects would improve the operators' access to
long-term funding, strengthen their capital structures, and ease the fiscal pressure on local governments.
Why Fares May Start To Rise
Attracting private investors would require the metro companies to run the networks on stronger commercial lines. And
that will mean tackling the untouchable: low fares. The government provides a guaranteed return to Beijing MTRC
Corp. for line 4 because the fares are too low to even cover operating expenses.
Beijing has had a flat fare of RMB2.0 since 2008, no matter how far the journey. That would be like crossing the whole
of New York city for just 33 U.S. cents. In Beijing, the low fares are designed to encourage more people to take the
subway in order to reduce traffic congestion and pollution. Average fares in neighboring Hong Kong are the equivalent
to US$1, still low for a major metropolis. Hong Kong fares are, however, enough to cover expenses and generate
reasonable returns. Furthermore, the fares are subject to an annual review that takes into consideration the consumer
price index and transport wage rises.
We estimate that BII would have to at least double ticket prices to cover its operating expenses. But any fare-setting
mechanism would need to be transparent, predictable, and consistent to ensure the adequate and timely recovery of
costs. Such a mechanism would help to improve operating efficiency and profitability, and reduce the need for
subsidies. And that would help to strengthen overall credit quality.
Property Development Isn't A Panacea
The "rail plus property" model of Hong Kong's MTRC could unlock potential income for metro companies in China.
MTRC's property portfolio, which the Hong Kong government allocates, generates income of Hong Kong dollar (HK$)
3 billion-HK$4 billion income each year. This cash flow supports the construction costs of railway projects and
contributes to future rail patronage from the immediate catchment areas that property developments have created.
MTRC enters into profit-sharing agreements with developers, which bear all the development costs. The Hong Kong
government fully funds the construction of new lines when property development is not an option.
Nevertheless, the current land auction system in China could limit the scope of metro operators to develop property.
WWW.STANDARDANDPOORS.COM/RATINGSDIRECT JUNE 11, 2014 5
1331246 | 301447691
Sector Review: How China's Metros Could Start To Pay Their Way
All the land for property development must be bought through public auction; it is not allocated to designated
developers. In Beijing, the government delegated BII the function of primary land development and land consolidation
to turn railway stations above ground into ready-to-sell land. The land is then handed back to the government for
public auction. BII earns a guaranteed return on its costs for land development. If BII can secure land at auctions, it
can then engage in property development.
We expect operators like BII to increasingly explore opportunities for property development. Income from this
segment will grow, but the contribution to metro development will still be low over the next few years. Over the long
run, BII aims to use the strong cash flow generated from its real estate business to support its core subway business.
While property projects could improve profitability, metro operators will also be subject to volatile market prices and
the risks of evolving regulations.
Key Credit Information For Major Regional Metro Operators
Beijing Infrastructure Investment
Co. Ltd. MTR Corp. Ltd. SMRT Corp. Ltd.
Total metro length as of 2013 (km) 465 About 200 About 150
Average daily ridership Nearly 9 mil. in 2013 About 4.1 mil. in 2013 About 2.6 mil. in 2012
Business risk profile Satisfactory Excellent Strong
Financial risk profile Highly leveraged Modest Minimal
Rating A+/Stable/-- AAA/Stable/A-1+ AAA/Negative/--
Stand-alone credit profile bb- aa- aa-
Likelihood of extraordinary government
support
Almost certain Almost certain Extremely high
--Average of past three fiscal years--
(Mil. mix curr.) CNY HK$ S$
Revenues 7,732.2 39,145.7 1,048.8
EBITDA margin (%) 15.7 42.8 26.6
Return on capital (%) 0.7 8.0 17.5
EBITDA interest coverage (x) 0.2 11.1 32.4
FFO cash int. cov. (x) 0.2 20.3 44.4
Debt/EBITDA (x) 120.7 1.4 0.4
FFO/debt (%) (3.6) 59.8 218.7
Cash flow from operations/debt (%) (8.8) 70.6 245.0
Free operating cash flow/debt (%) (30.7) 21.6 71.9
Discretionary cash flow/debt (%) (32.7) 3.0 (35.5)
Rating as on June 10, 2014.
Further Down The Line
Metro peers in Singapore and Hong Kong have stronger stand-alone credit profiles than their peers in China because
of their flexibility to increase fares as needed under a transparent fare-setting mechanism. This enables them to
recover costs more quickly and achieve higher returns. They also have stronger cash flows from retail outlets at
stations and other commercial businesses, and property income. Until Chinese metro peers have similar flexibility,
WWW.STANDARDANDPOORS.COM/RATINGSDIRECT JUNE 11, 2014 6
1331246 | 301447691
Sector Review: How China's Metros Could Start To Pay Their Way
their stand-alone credit profiles will remain constrained.
We expect the ridership on metro lines to almost double in China over the next four years, offering strong revenue
potential. In 2013, Beijing alone had an average of nearly 9 million rides per day. But such expansion will mean higher
construction costs.
If the metros can diversify their funding sources and improve their profitability through fare adjustments and expanded
income sources, the fiscal strain on local governments could ease. And that in turn could help the economy stay on
track. The likely unpopularity of fare rises while the economy slows means governments may be reluctant to consider
this. But the signals could change.
Related Criteria And Research
Related Criteria
Key Credit Factors For The Transportation Infrastructure Industry, Nov. 19, 2013
Related Research
Beijing Infrastructure Investment Co. Ltd. Assigned 'A+' Corporate Credit Rating; Outlook Stable, March 7, 2014
How Risky Is The Spike In China's Public Debt?, Jan. 23, 2014
Under Standard & Poor's policies, only a Rating Committee can determine a Credit Rating Action (including a Credit
Rating change, affirmation or withdrawal, Rating Outlook change, or CreditWatch action). This commentary and its
subject matter have not been the subject of Rating Committee action and should not be interpreted as a change to, or
affirmation of, a Credit Rating or Rating Outlook.
WWW.STANDARDANDPOORS.COM/RATINGSDIRECT JUNE 11, 2014 7
1331246 | 301447691
Sector Review: How China's Metros Could Start To Pay Their Way
S&P may receive compensation for its ratings and certain analyses, normally from issuers or underwriters of securities or from obligors. S&P
reserves the right to disseminate its opinions and analyses. S&P's public ratings and analyses are made available on its Web sites,
www.standardandpoors.com (free of charge), and www.ratingsdirect.com and www.globalcreditportal.com (subscription) and www.spcapitaliq.com
(subscription) and may be distributed through other means, including via S&P publications and third-party redistributors. Additional information
about our ratings fees is available at www.standardandpoors.com/usratingsfees.
S&P keeps certain activities of its business units separate from each other in order to preserve the independence and objectivity of their respective
activities. As a result, certain business units of S&P may have information that is not available to other S&P business units. S&P has established
policies and procedures to maintain the confidentiality of certain nonpublic information received in connection with each analytical process.
To the extent that regulatory authorities allow a rating agency to acknowledge in one jurisdiction a rating issued in another jurisdiction for certain
regulatory purposes, S&P reserves the right to assign, withdraw, or suspend such acknowledgement at any time and in its sole discretion. S&P
Parties disclaim any duty whatsoever arising out of the assignment, withdrawal, or suspension of an acknowledgment as well as any liability for any
damage alleged to have been suffered on account thereof.
Credit-related and other analyses, including ratings, and statements in the Content are statements of opinion as of the date they are expressed and
not statements of fact. S&P's opinions, analyses, and rating acknowledgment decisions (described below) are not recommendations to purchase,
hold, or sell any securities or to make any investment decisions, and do not address the suitability of any security. S&P assumes no obligation to
update the Content following publication in any form or format. The Content should not be relied on and is not a substitute for the skill, judgment
and experience of the user, its management, employees, advisors and/or clients when making investment and other business decisions. S&P does
not act as a fiduciary or an investment advisor except where registered as such. While S&P has obtained information from sources it believes to be
reliable, S&P does not perform an audit and undertakes no duty of due diligence or independent verification of any information it receives.
No content (including ratings, credit-related analyses and data, valuations, model, software or other application or output therefrom) or any part
thereof (Content) may be modified, reverse engineered, reproduced or distributed in any form by any means, or stored in a database or retrieval
system, without the prior written permission of Standard & Poor's Financial Services LLC or its affiliates (collectively, S&P). The Content shall not be
used for any unlawful or unauthorized purposes. S&P and any third-party providers, as well as their directors, officers, shareholders, employees or
agents (collectively S&P Parties) do not guarantee the accuracy, completeness, timeliness or availability of the Content. S&P Parties are not
responsible for any errors or omissions (negligent or otherwise), regardless of the cause, for the results obtained from the use of the Content, or for
the security or maintenance of any data input by the user. The Content is provided on an "as is" basis. S&P PARTIES DISCLAIM ANY AND ALL
EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF MERCHANTABILITY OR FITNESS FOR
A PARTICULAR PURPOSE OR USE, FREEDOM FROM BUGS, SOFTWARE ERRORS OR DEFECTS, THAT THE CONTENT'S FUNCTIONING
WILL BE UNINTERRUPTED, OR THAT THE CONTENT WILL OPERATE WITH ANY SOFTWARE OR HARDWARE CONFIGURATION. In no
event shall S&P Parties be liable to any party for any direct, indirect, incidental, exemplary, compensatory, punitive, special or consequential
damages, costs, expenses, legal fees, or losses (including, without limitation, lost income or lost profits and opportunity costs or losses caused by
negligence) in connection with any use of the Content even if advised of the possibility of such damages.
Copyright 2014 Standard & Poor's Financial Services LLC, a part of McGraw Hill Financial. All rights reserved.
WWW.STANDARDANDPOORS.COM/RATINGSDIRECT JUNE 11, 2014 8
1331246 | 301447691