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Morningstar | Central Japan Railway's 2Q Margins Positive, but FVE Lowered on Chuo Shinkansen Project Risks

Central Japan Railway, or JRC is the second-largest railway network operator deriving 94% of its operating profit from the rail business. Merchandise and real estate accounts for the balance. The rail segment’s high profitability is primarily driven by the Tokaido Shinkansen, which connects Tokyo to Osaka via Nagoya and has historically garnered superior margins to Shinkansen lines operated by its peers. Commuters travelling to Nagoya or Osaka from Tokyo have preferred Shinkansen to airlines due to significantly higher frequency of daily departures, comparable travel time, and the safety and reliability offered by the former. As a result, JRC boasts a 100% and 86% market share (versus airlines) for the Tokyo-Nagoya and Tokyo-Osaka routes, respectively. However, JRC’s free cash flow over the next twenty years is sensitive to spending on the JPY 9 trillion Chuo Shinkansen line. While the Chuo line will be technologically superior to the current Nozomi express train service and is expected to slash the travel time to Nagoya and Osaka from Tokyo by at least half versus the current shinkansen line, the high cost of its development indicates that train fares will have to be much higher in order to generate a positive return above its estimated cost of capital. Given the large initial capital outlay of the project, we expect JRC to largely generate negative free cash flow in the next 10 years. Unlike Tokaido Shinkansen whose fares are regulated by the government, we think that there will be minimal intervention by the authorities for the privately-developed Chuo line, enabling JRC to set price freely. We estimate that Chuo fares will be 60% higher than those on the current Nozomi line, and that 50% of riders on the Chuo line are commuters switching from Tokaido Shinkansen, with the balance made up by new riders. This will yield the project a net present value of JPY 2.7 trillion. Given the economic significance of the project and JPY 3 trillion of low-cost financing provided by the government, we think that there’s still a chance that government might step in with subsidies in the event of costs over-run or poor ridership volume.