Fitch Ratings has affirmed Shenzhen International Holdings Limited's (SZIH) Long-Term Issuer Default Rating (IDR) at 'BBB+'.

The Outlook is Negative.

RATING RATIONALE

SZIH's IDR incorporates a two-notch uplift from its standalone credit profile (SCP) under Fitch's Parent and Subsidiary Linkage Rating Criteria.

SZIH's SCP reflects the combined credit profile of its toll-road operations, and its environmental protection and logistics businesses. The toll-road portfolio is owned and operated by its 51.56%-owned subsidiary, Shenzhen Expressway Corporation Limited (SZE, BBB+/Negative), which accounted for 66% of revenue in 2022.

The Negative Outlook reflects our expectation that net leverage will remain high in the medium term, driven by a pandemic-related decline in EBITDA in 2022, reliance on short-term debt and previous debt-funded expansions.

Fitch expects deleveraging to commence when new assets begin to contribute meaningful income and management's effort to monetise the company's assets start to crystallise. This includes spinning off its logistics assets gradually through the establishment of infrastructure REITs as well as redevelopment of certain logistics parks earmarked for urban development, such as the South China Logistics Park.

These real-estate developments are likely to mirror SZIH's past real-estate involvement in Meilin Checkpoint and Qianhai Project, where SZIH recouped its initial investments by diluting its interest in these projects while minimising exposure to volatile property prices and policy uncertainties.

Following the termination of SZE's public-private partnership (PPP) arrangement for the Jihe Expressway expansion, expansion and financing plans remain uncertain. Finalisation of the project details and a heavily debt-funded expansion plan would trigger a review of the rating.

KEY RATING DRIVERS

Moderate Linkage with Parent

Shenzhen Investment Holdings Co., Ltd. (SIHC, A+/Stable) holds a 44.35% controlling interest in SZIH. SZIH is notched 'bottom-up plus two' from SIHC's IDR under the 'stronger parent' path, based on 'Weak' legal and 'Medium' strategic and operational linkages with its parent. This reflects SIHC's moderate incentive to support SZIH if needed, driven by the subsidiary's strategic importance to the parent due to its stable cash flow contribution, competitive advantages and high growth potential.

Strategic, Robust Expressway Network - Revenue Risk (Volume): High Midrange

The volume risk reflects the company's robust expressway portfolio and the higher risks faced by its logistics and environmental protection businesses. SZE operates a medium-scale expressway network in China, comprising 16 expressways and bridges. Most of its core assets are strategically spread across the wealthy Guangdong province, including Shenzhen city, while three are in central China. The operating portfolio covers key arterial roads with large commuter bases and limited competition. Toll traffic was robust and toll revenue recovery was swift after the removal of pandemic-related restrictions.

The logistics business, however, has higher execution risks than the toll-road business. The company's increasing efforts to expand in logistics limits volume risk to 'High Midrange'.

Opaque Regulatory Framework - Revenue Risk (Price): Weaker

Price risk is a weaker attribute due to lack of transparency and predictability in the regulatory framework. Toll-rate setting and adjustments are highly regulated by the government with limited flexibility for toll-road operators to recover higher costs due to inflation. Most of the prevailing toll rates have been unchanged for a number of years with no visibility of any increases in the future.

The government has imposed adverse policies such as tariff cuts and toll exemptions, resulting in a decline in the average toll rate. However, we believe these policies will reduce congestion on road networks and boost traffic, which will benefit the company in the long run.

Large-Scale, Debt-Funded Capex Plan - Infrastructure Development and Renewal: Midrange

We forecast SZIH's capex to be substantial, particularly in the next one to two years, with major expansion of existing toll roads as well as construction and upgrades of logistics parks to include cold-chain and smart-warehouse features. The medium-term capex plan is well-developed and detailed. SZE has long experience and expertise in delivering results for investments in its expressways, while SZIH has extensive experience in building and operating logistics parks and hubs. We expect the planned capex to be largely funded by debt, which is likely to strain SZIH's leverage in the medium term.

Non-Amortising Uncovenanted Debt - Debt Structure: Midrange

SZIH's debt structure is typical of a Chinese corporate borrower as it is funded by non-amortising debt with few of the protective covenants that would be commonly seen in a project finance-type structure. Refinancing risk is mitigated by the company's ample liquidity, comprising cash and significant standby bank facilities, a well-diversified schedule of bullet maturities, a record of prudent debt management and solid access to the capital market.

Currency risk arising from its US dollar bonds is substantially hedged. Interest-rate risk relates to the country's benchmark lending rate and the loan prime rate set by China's central bank, but the risk is manageable as adjustments to the two rates are infrequent and have been kept low.

Financial Profile

We expect SZIH's logistics business growth in the medium term to be largely driven by the addition of new logistics parks, although occupancy and rental rate growth are likely to be modest in the near term due to a slowdown in the global manufacturing sector and exports in China.

Fitch's base case (FBC) assumptions are largely in line with management's forecast. It projects about 3% yoy revenue growth for SZIH's logistics business in the next two years on weaker port performance. We expect higher yoy revenue growth (about 10% to 15%) between 2025 and 2027 as several larger logistics parks commence operation, such as the Yantian and Pingshan projects. The average EBITDA margin will be around 50%. We expect Shenzhen Airlines to only start contributing meaningful dividend income in 2025 due to significant accumulated losses incurred during the pandemic.

Fitch's rating case (FRC) takes a more conservative stand and incorporates a number of stresses, with logistics revenue in 2023 to remain at the 2022 level. Fitch has assumed an almost 50% discount on Shenzhen Airlines' dividend income projected in the FBC. The FRC projects a 2pp haircut in logistics business revenue growth between 2025 to 2027. Fitch also adopted a narrower EBITDA margin of about 2pp in 2023-2027, 200bp increase in the floating interest rate, 3% stress on capex and 2pp increase in the dividend payout ratio.

We have not taken into consideration income contribution and capex for the redevelopment of the South China logistics park in both our FBC and FRC due to lack of clarity on the development and financing plan. We believe the redevelopment will be critical to SZIH's deleveraging as it is a much bigger development than SZIH's previous real-estate projects and is strategically located in Shenzhen city.

The FBC and FRC also do not factor in revenue growth and capex arising from the Jihe Expressway expansion due to high uncertainty around the expansion and financing plan after the termination of SZE's PPP arrangement with local authorities.

FBC net leverage is expected to drop significantly to 4.0x in FY23 due to dividend contribution arising from Qianhai's divestment. Net leverage will peak at 5.1x in 2024, before declining gradually below 4.5x in FY25. The projected five-year average net leverage is 4.5x.

Similar to the FBC, FRC net leverage is expected to drop significantly in FY23, peak at 5.8x in 2024, then decline to around 5.5x in FY25. The projected five-year average net leverage is 5.3x.

PEER GROUP

SZIH's closest peer is Yuexiu Transport Infrastructure Limited (YXT, BBB/Stable), because the toll-road business remains SZIH's major earnings and cash flow contributor. SZIH has a larger portfolio than YXT, with key assets strategically located in a well-developed region with limited competition, while YXT has better geographic diversity and a longer remaining concession life.

YXT's infrastructure development and renewal factor is assessed as 'Stronger' because of its smaller scale and lower complexity, while SZIH's is limited to 'Midrange' because of its substantial debt-funded investment plan. SZIH's elevated net leverage in the medium term demonstrates a weaker financial profile than YXT, justifying its weaker SCP. Under the FRC, YXT's five-year average net leverage is 3.8x.

RATING SENSITIVITIES

Factors that Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade

Weakening of linkages between SZIH and SIHC;

Deterioration in SZIH's SCP credit profile with net debt/EBITDA higher than 5.5x on a sustained basis, provided the linkage between SZIH and SIHC remains intact.

Factors that Could, Individually or Collectively, Lead to Positive Rating Action/Upgrade

Strengthening of linkages between SZIH and SIHC, provided SZIH's SCP stays intact;

SZIH's SCP is not expected to improve in the medium term due to the group's significant investment plans.

Best/Worst Case Rating Scenario

International scale credit ratings of Sovereigns, Public Finance and Infrastructure issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of three notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.

CREDIT UPDATE

Overall revenue in FY22 fell by 16% yoy, mainly due to SZE's weaker performance. SZIH's logistics parks, however, recorded 14% yoy revenue growth in FY22, benefiting from several acquisitions of operational logistics assets in the past two years and launches of new logistics parks.

SZIH's net leverage increased to 6.7x in 2022, from 4.9x in 2021, as a result of major acquisitions and aggressive expansion plans over the past few years. This includes the acquisition of Shenzhen Investment International Capital Holdings Infrastructure Co. Ltd by SZE.

Short-term debt obligations rose to 55% of total debt in FY22, from 37% in FY21, largely contributed by SZE. However, liquidity risk is mitigated by SZIH's solid access to capital markets, as well as adequate cash and unused credit facilities to cover its debt obligations in FY23.

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

ESG Considerations

Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg

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