Ride Safely on China’s Highways
We initiate coverage on China’s Toll Road Sector with
a Positive view as the sector is a good proxy to
China’s medium to long-term growth, whilst offering
a defensive profile with attractive dividend yields.
Our top picks are Jiangsu Expressway (BUY, TP
HK$7.19) and Anhui Expressway (BUY, TP HK$3.98).
Safe proxy to China's medium to long-term growth.
Although China's economic growth is expected to slow to
8% in 2009, it should still provide sufficient impetus to
drive traffic growth for its expressways. China's toll road
sector is still a sunrise industry, with rising car ownership
and urbanisation driving traffic growth and more highways
to be built providing potential acquisitions for toll road
companies to grow in the long-term.
Strong financials with attractive dividend yields.
Companies in this sector generally have strong balance
sheets supported by healthy cash flows, given the cash
nature of its business model. Moreover, companies in this
sector pay out between 50%-100% of earnings as
dividends, resulting in attractive dividends on offer.
Currently, various companies in the sector offer prospective
dividend yields of between 4.9% to as high as 10.6%.
Valuations ripe for investors to enter. While the PRC
toll road sector has outperformed the HSCEI in the last 6
months, given its low beta and defensive profile, the
spread between the sector’s dividend yields and
government bond yield in Hong Kong has also widened
substantially over the same period as interest rates have
fallen. With implied yields trading well above their historical
range, we believe this is a good time for investors to buy
into this sector, especially for those who remain cautious in
the current volatile equities market environment.

Investment Summary
China’s Expressway industry is still in its growth phase, with its
first expressway only emerging in 1988. Since then, the total
length of expressways in China has grown from just 500km at
the end of 1990 to almost 54,000km by the end of 2007. This
represents a CAGR of over 30%.
This phenomenal growth has been driven by and has also
helped to drive China’s booming economy. Statistics show that
strong correlation exists between traffic flow and GDP.
Excluding the inflationary factor in the GDP, the CAGR of
China’s real GDP would range between 9.5% and 10.0%
through 2000 to 2007, very much in tandem with the growth
rates of traffic flow over the same period.
By 2020, China’s total expressway length could reach
100,000km. According to the latest news from the Ministry of
Transport, China plans to complete its National Expressway
Network by 2020. The National Expressway Network will have
a total length of 85,000km and become the arteries of the
country’s road network. By end 2008, 49,000km of the
National Expressway Network will be completed, and
14,000km will be under construction, while another 22,000km
has yet to start construction.
On the roads itself, traffic volumes are driven by the economic
growth of its respective regions. Generally, the more
developed coastal provinces with higher GDP growth rates
have seen a faster growth of traffic volumes.
Other key drivers include rising private car ownership and also
increasing urbanization. The number of privately owned
vehicles increased from 6.3mn in 2000 to 28.8mn in 2007,
representing CAGRs at 24.4%. During the same period,
urbanization rate also increased consistently from 36.2% in
2000 to 44.9% in 2007. Looking ahead, continued
urbanisation should continue to help drive traffic growth in the
long term.
Currently, toll concessions do not exceed 25 years, and no
longer than 30 years for mid and western provinces. After
building a toll road, toll road companies are usually granted a
concession period, in which they are entitled to charge tolls
from the traffic volumes. After the concession period, the
roads will be transferred to the Chinese government free of
charge. According to relevant regulations in China, such
concession periods shall not exceed 25 years in eastern
provinces or 30 years in mid and western provinces. The longer
concession period in mid and western provinces is in place in
order to encourage more investment in the less developed mid
and western part of China. The average number of years left in
toll road concessions for companies in our coverage is 20 years
or more.
Toll rates also subject to provincial governments’ approval. Toll
road companies can propose their toll rate schemes and/or
changes to toll rate schemes to respective provincial
governments. No toll rate scheme could come into effect prior
to provincial governments’ approval.
Generally, our Group of 5 HK-listed toll road companies have
grown their core earnings steadily, from a total of RMB3.1b in
2003 to an estimated RMB5.8b in 2008, at a CAGR of 13.0%,
driven by growth in traffic volumes.
Dividends from the 5 companies have also been growing
consistently from RMB2.5b in 2003 to an estimated RMB4.0b
in 2008, at a CAGR of 10.3%, while the general dividend
payout ratio has always been 60% or more during the period.
Strong balance sheets, with healthy cash flows and good
interest coverage ratios. By end 2008, we estimate the net
debt/equity ratio of 4 out of the 5 companies would remain
below 0.5x, with Shenzhen Expressway the only exception at
1.0x due to its huge capex plan. Healthy operating cashflow is
a typical feature of toll road companies. With toll revenue
flowing in consistently, EBITDA/interest ratio is at least 5x for
any of the HK-listed toll road companies under our coverage.
Low beta, defensive sector. Compared to the broader Hang
Seng China Enterprises Index, PRC toll road companies have
under-performed over most of the last three years, during the
bull-run. Over the last 6 months though, the sector has outperformed
the HSCEI, which is especially true for larger cap
stocks such as Jiangsu Exp, Zhejiang Exp and Hopewell
Highway.
Spread over risk-free rate has widened substantially. Since July
2008, yields for PRC toll road companies have increased, and
are trading well above their historical average yields. More
significantly, dividend yields have been increasing even as the
risk-free rate has been declining (as proxied by 10-year Hong
Kong government bond, which has declined from over 3% in
July 2008 to c. 1.2% currently). This means that the spreads
have widened substantially, implying that valuations for the
sector have become more attractive.
Valuations attractive compared to regional peers considering
stronger growth prospects. Our group of toll road companies is
trading at an average of 11x earnings, which is comparable to
regional peers, whilst offering more attractive dividend yields
of between 4.8 and 10.6%, with stronger growth prospects.
We have a Positive view on China’s Toll Road Sector; and
initiate coverage on 5 companies in the sector with 3 BUY calls
and 2 HOLD calls. We believe the sector offers a defensive
profile with companies providing attractive yields of at least
4.8% to more than 10%, whilst also having a solid medium to
long-term growth profile, riding on China’s economic growth
and rising freight and passenger traffic.

Table of Contents
Investment Summary 3
History and Overview of Toll Roads in China 5
Growth Drivers 5
Blueprint of China’s Expressway Network 6
Funding Sources and Issues 9
Regulatory Framework 9
Traffic and Toll Rates 11
Key Risks 12
Listed PRC Toll Road Companies 12
Comparisons of Toll Roads Under Coverage 13
Valuations 18
Stock Profiles
Jiangsu Expressway 22
Zhejiang Expressway 40
Anhui Expressway 60
Shenzhen Expressway 80
Hopewell Highway 102
China Merchant Hldgs (Pacific) 120