China State Build-Tranfer project fears

Analysis, Slider 21 Aug 2013
China State Build-Tranfer project fears

Concern over exposure to local government debt

The share price of mainland giant China State Construction International (3311) could come under pressure due to its exposure to mainland projects where the clients are local governments with heavy debts.

A research report by Barclays earlier this week said that it preferred construction stocks outside of Japan with exposure to the China market and the railway construction market there.

It said that China Railway Construction Corporation (1186) and China Railway Group (0390) should outperform China State on the back of the Chinese economy stabilizing and renewed investment in the railway system.

This was because both companies had lower risk exposure to local government debt compared with China State.

“Meanwhile, [China State]’s valuation is becoming increasing vulnerable to concerns on local government debt given its increased earnings contribution from BT projects,” the research report said.

In its 2012 annual report, the company said it devoted much effort in the infrastructure investment business in China during the year, in particular targeting build-transfer (BT) projects for affordable housing.

In recent years, the central government has made the provision of affordable housing a top priority to defuse public anger over rocketing property prices.

In the current Twelfth Five Year Plan for 2011-2015, the government’s target is to provide 36 million units of affordable housing.

In affordable housing projects, local governments engage contractors to build the housing and only pay for them when the project is completed and transferred.

That means the contractors have to cough up the capital investment upfront first.

According to the 2012 annual report, China State had trade receivables of HK$9.33 billion on its balance sheet, up from only HK$3.69 billion in 2010 when it started its first affordable housing project in Tianjin.

Out of the HK$9.33 billion, HK$3.19 billion from affordable housing is due to be received in the years 2014, 2016 and 2017.

At the end of 2012, China State had eight BT projects and 10 BOT (Build-Operate-Transfer) projects on its books.

China State carried out its first Build-Transfer project for affordable housing in Tianjin   (China State Construction International website)

China State carried out its first Build-Transfer project for affordable housing in Tianjin (China State Construction International website)

Local governments have been on massive borrowing binge in recent years to meet their own spending needs as well as have funds for investment projects as directed by the central government.

With concern mounting on the debt mountain, the State Council last month ordered the National Audit Office to audit all government debt.

Barclays estimated that China State would have 44 percent of its 2014 revenues coming from BT projects putting it at risk if local government debt blows up.

By comparison, China Railway Construction and China Railway Group are expected to have only about 10 percent of revenues from BT projects.

The Barclays report also pointed to differences in revenues by geographical origin.

It estimates that for 2014, China Railway Construction and China Railway Group would have more revenue from China, at 90 percent, compared with 49 percent for China State.

It noted the share prices of China Railway Construction and China Railway Group have outperformed China State’s since last month due to positive news such as upgraded railway spending targets and better Chinese macro data.

In mid-July the share price of China Railway Construction stood at about HK$7 whereupon it subsequently climbed by 14 percent to close at HK$7.87 yesterday.

By comparison, during the same period the share price of China State rose slightly from about HK$12.3 to only HK$12.52.

Barclays said increased railway spending in the second half of 2013 and 2014 would help boost the performance of shares of China Railway Construction and China Railway Group.

Danny Chung

 

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