President Death Leaves Heir Overdue Rail Payments: China Credit

Jan 12, 2014 10:53 pm ET

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Jan. 13 (Bloomberg) -- The death of China Railway Group Ltd.’s president left his successor an escalating challenge: collecting on unpaid construction-work bills in an industry plagued by record debt as borrowing costs surge.

Shares in China’s second-biggest builder of railways fell 7.4 percent in Hong Kong last week after the company said Jan. 5 that President Bai Zhongren had died in an accident and that Chairman Li Changjin will take over his job before a successor is chosen. The yield on 2023 dollar-denominated debt of a company unit reached an eight-week high of 5.03 percent on Jan. 9, up from 3.88 percent when they were sold last January.

Premier Li Keqiang’s efforts to reduce leverage in the world’s second-largest economy are leaving Chinese companies short of cash to pay banks and contractors. China Railway Group’s liabilities and accounts receivable both more than doubled in the past five years, an increase Sun Hung Kai Financial Ltd. said reflects difficulty collecting payments on time from China Railway Corp., the operator of a network plagued by corruption probes and fatal accidents.

“The death of Mr. Bai renewed market concerns on China’s rail sector, which had project delays caused by corruption investigations and suffered from massive debts,” said Eva Yip, an analyst at Sun Hung Kai Financial. The stock fell amid a lack of details over Bai’s death and concern that further probes are in the pipeline, she said.

Rail Expansion

China has built a high-speed rail network of 11,000 kilometers (6,835 miles) in six years as the centerpiece of a debt-fueled stimulus package after the global financial crisis. The expansion spawned abuses with former railway minister Liu Zhijun given a suspended death sentence in July for taking bribes.

A high-speed crash killed 40 people in 2011, prompting the government to disband the railway ministry and hand its operations to 100 percent state-owned China Railway Corp. in March last year. The similarly named China Railway Group and China Railway Construction Corp. have a duopoly on building for the network and are majority owned by separate government bodies.

China Railway Group declined to give more details on president Bai’s death, according to an e-mailed statement by Hill+Knowlton Strategies, which handles the company’s media relations. The builder’s debt level is normal and risks are controllable, according to a statement posted to Shanghai’s stock exchange website last week.

Overdue Payments

The Beijing-based company had 531.6 billion yuan ($87.8 billion) of liabilities on Sept. 30, data compiled by Bloomberg show. Its long-term debt to equity ratio of 129 percent is among the worst 3 percent on the Hang Seng Index, while its ability to cover interest payments with earnings is in the worst 1 percent.

Its debt was already underperforming. The extra yield investors demand to hold its 2020 yuan notes over similar- maturity AAA bonds surged to a four-month high of 24 basis points on Dec. 26. The premium on 10-year securities from China Railway Corp. over government notes has risen to 172 basis points, near the highest since 2011.

China Railway Group’s increasing accounts receivables is mainly caused by overdue payments from its main customer China Railway Corp., Sun Hung Kai Financial’s Yip said.

Separately, Yip said that China Railway Construction told her on Jan. 7 that payment delays are normal and usually it has to chase its railway customers several times before it gets paid. “Certain individual customers” of China Railway Construction haven‘t been able to pay on time for years and there’s no obvious change at the moment, according to an e- mailed statement on Jan. 9 by Wonderful Sky Financial Group, which handles media relations for the construction company.

Debt-Fueled

“China Railway Corp. is the worst customer in terms of difficulties to get paid on time,” said Wang Mengshu, chief deputy engineer of China Railway Group, citing his inspection trip to a line it is building between the cities of Lanzhou and Chongqing. The massive debt of the network operator is one reason for the delayed payments, he said.

Two officials in China Railway Corp.’s department that handles media inquiries and one in its International Cooperation Department declined to comment when reached by phone, citing company policy. There was no immediate reply to two faxed requests for comment. A Bloomberg reporter who visited the company’s office in Beijing was directed to a visitor registration area and dialed through to an official in the press office who said that an interview would not be possible at this time.

Record Liabilities

The company’s total liabilities reached a record high of 3.1 trillion yuan as of the end of September, equivalent to the government debt of Brazil. It sold 190.4 billion yuan of notes last year, the most for any corporate borrower, as Premier Li vowed to accelerate network expansion to help develop inland cities and bolster economic growth.

“Because China Railway Corp.’s existing projects can’t bring positive returns, it has to rely on loans and bond sales to fund new projects,” said Ivan Chung, a Hong Kong-based senior credit officer at Moody’s Investors Service. “Growth in the debt will only go faster as China pushes forward the urbanization drive.”

Haitong Securities Co., China’s second-biggest brokerage, said earlier this month that a "debt snowball" threatens to trigger a financial crisis as more companies borrow to fund maturing obligations and unpaid bills. Liabilities at non- financial corporates may rise to more than 150 percent of gross domestic product in 2014, raising default risks, according to Haitong. The ratio of 139 percent at the end of 2012 was already the highest among the world’s 10 biggest economies, according to the most recent data.

Surging Yields

The yield on the benchmark 10-year sovereign bond has jumped 101 basis points in the past year to 4.61 percent, as money-market rates surge.

“Compared with other sectors, rail companies are definitely more vulnerable to any sort of tight liquidity in money markets,” said Gary Wong, a Hong Kong-based analyst at Guotai Junan Securities Co. “That’s because they have huge debts and difficulties in getting project payments on time.”

China Railway Group had a negative cash flow of 18.5 billion yuan in the first nine months of 2013, heading for a fourth consecutive year of outflows. It posted a 10 percent increase in net income to 7.4 billion yuan in 2012 and reported a 5 percent increase in sales to 465.6 billion yuan.

Ratings

The government has previously provided support to make sure the network operator makes good on overdue payments, said Cosmo Zhang, Hong Kong-based director at Corporate Ratings Group at Fitch Ratings, which rated the 2023 debt BBB+ with a stable outlook.

“We adopt a top-down approach in rating China Railway Group and link its rating to China’s sovereign rating due to the company being one of the two players in China’s railway construction duopoly, and because of the importance of railway construction to the country,” he said. “We didn’t take into consideration the company’s debt levels when rating the company.”

Standard & Poor’s said its similar rating also focused on the prospects of a bailout for the industry if required.

There is a “high likelihood of timely and sufficient extraordinary support from the government of China in the event of financial distress,” said Huma Shi, director of corporate ratings. The rating also “factored in its aggressive financial risk profile which is reflected by its high leverage and volatile free operating cash flows,” Shi said.

--Jasmine Wang and Judy Chen, with assistance from Daryl Loo in Beijing. Editors: Andrew Monahan, Sandy Hendry