The former Ministry of Railway’s restructuring activity has raised questions to whether the Ministry of Finance (MoF) will continue to provide support for its upcoming renminbi bond auction. Investors are likely to price in risk premiums as a result of this uncertainty.
China Railway Corporation (China Railway) will make its capital market debut with the sale of Rmb20 billion (US$3.25 billion) in bonds this week, raising funds that are needed to kick the country’s ambitious railway plans back in action, according to The Financial Times. The auction of its five-year bonds is scheduled to begin on May 23.
Although China Railway remains state-owned and the government has said it will fully backstop all of its debt, the MoF hasn’t explicitly issued a guarantee for the corporate, is which raising questions among investors.
“The main concern is whether China Railway will continue to receive the support from Ministry of Finance because the existing bonds issued by former Ministry of Railway are essentially guaranteed by the MoF,” said Patrick Xu, equity research analyst at Barclays to Asiamoney PLUS in a telephone interview on May 21. “For China Railway, we haven’t got an explicit guarantee from the MoF.”
Beijing disbanded the country’s once-powerful railway ministry in March after it was hit by a series of corruption and safety scandals, including a bullet train crash that killed 40 people in 2011.
The government split the ministry’s functions in two. It created a railway bureau under the transport ministry that is responsible for approving investment plans and monitoring safety. The other part of the ministry was reconstituted as China Railway, the main national rail operator. The entity is expected to function like corporate, publishing more detailed financial statements.
China Railway’s corporate-like structure raises worries to investors to whether government would salvage it if it defaults, note experts.
“A ministry cannot go bankrupt but a corporation can. This is one of the reasons why if it goes bad, the government could allow some of the subsidiaries to go bankrupt. Although it is unlikely, but you cannot say that it is impossible,” said Gary Wong, analyst at Guotai Junan Securities.
As a result, experts are calling for investors to price in risk premiums into the China Railway’s upcoming bond auction given its uncertainty, potentially leading the corporate to offer yields above its previous notes.
The Ministry of Railway’s last bond issuance was in October 2012, when it issued a two-tranche Rmb20 billion bond. The first tranche was a seven-year note of Rmb10 billion while the second was a 20-year in equivalent size with coupons of 4.57% and 5.11% respectively, according to Dealogic data.
Market participants believe that the upcoming bonds should be priced around the 4.8% level for a seven-year up to 5.2% for tenors beyond seven years in order to attract domestic investors.
“I don’t think people have lost much confidence in this name but people are definitely more concerned than before,” said Xu. “These new bonds will be priced at a slightly higher yield than the existing bonds.”
Also, based on the fact that this is China Railway’s maiden bond post-restructuring, some investors – who were once avid supporters of the organisation – could adopt a ‘wait-and-see’ mentality.
“The risk/return ratio of the upcoming China Railway’s bond is not that good. It will be fully subscribed but it won’t be oversubscribed by many times,” said Wong. “This is the first renminbi bond issued by the corporate and I think a lot of investors will step aside to see whether the bond will be widely accepted and would prefer to go into the market the next time.”
The bonds are the first batch of the Rmb150 billion in notes that China Railway is expected to issue this year as it plows ahead with a blueprint to lay about 30,000km of new tracks over the next decade.
Lianhe Credit Rating rated China Railway’s bonds ‘AAA’, citing the company’s dominant position in the country’s fast-growing rail industry.
Ministry of Railway restructuring positive
While there are uncertainties with regards to the official status of China Railway, the long-term implications of the entity’s restructuring is positive for the infrastructure industry as a whole.
“It’s good to strip out the administrative functions from the operations. China Railway’s responsibilities are now more aligned with a typical business-driven enterprise,” said a Hong Kong-based equity analyst to Asiamoney PLUS. “It also makes the asset ownership clearer. Previously the assets held by the Ministry of Railway are government assets but now it’s a corporate. So it opens door to much more flexible means of financing arrangements.”
Breaking up the ministry could improve fundraising for the rail industry, after the Wenzhou crash made financing more difficult and as debt has mounted. As a result, the corporation will be able to issue more bonds in the future and could potentially embark on an initial public offering (IPO) using its assets as collateral, highlight experts.
Via the equity offering route, private capital investors will be able to contribute to future Chinese railway construction projects, driving economic efficiency and increase transparency.
“The government would need to grant private investors the authority to invest into railway-related projects so that it can improve social monitoring,” said Guotai Junan’s Wong.