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Morningstar | JE’s Recurring 2018 Growth in Line; Dividend Payout Ratio Drop to 60% on Recurring Profit.

Narrow-moat Jiangsu Expressway’s, or JE’s, strong 22% net profit growth was largely boosted by noncash asset revaluation gains, while its recurring earnings of CNY 3.9 billion was in line with our expectations, representing 8% year-over-year growth. The result, however, points to a weak fourth quarter, with recurring profit falling 4% from a year ago, compared with 14% growth in the third quarter. This is in line with our expectation and reflects a slowing economy in China, as well as impact from the U.S.-China trade impasse. We maintain our key assumptions but tweak our earnings forecasts to incorporate the earnings contributions from the Zhendan Expressway that commenced in October 2018 and is 70% owned by JE. We expect JE’s recurring net profit to rise 3.8% and 6.0% in 2019 and 2020 respectively, to CNY 4.0 billion and CNY 4.2 billion.

Accordingly, we raise our fair value estimate slightly to HKD 11.20 per share from HKD 11.10. We think the shares are fairly valued, with dividend yield at 4.8% compared with a normalized 5.0%-5.5%.

Fourth-quarter traffic growth on JE’s core Shanghai-Nanjing expressway slowed to 1% from 6% in the third quarter. While the weather had some negative impact, we think the primary reason is the slowing economy, which may also reflect indirect impact from the U.S.-China trade war. We think the U.S-China trade war is likely to be prolonged, which could weaken China’s activity levels and weigh on China’s exports, and it is negative for JE’s truck/cargo volume growth. But we think the downside is manageable, as truck/cargo volume makes up only 20% of the overall traffic on the Shanghai-Nanjing expressway. We continue to expect the company’s stable business outlook, robust cash flows and potentially higher dividend payouts to drive its long-term investment value.

Despite the stable growth on JE's toll assets, the concession rights for most of its toll roads will end by 2032. This includes JE’s core Shanghai-Nanjing Expressway, which contributes more than 70% of the operating profit from toll assets. To replenish the company's long-term growth, JE has invested on four new toll projects since 2016, costing CNY 22 billion, including Wufengshan Toll Bridge, Zhendan Expressway, Changyi Expressway and Yichang Expressway. The heavy capital spending has led to declines in dividend payout ratios to 60% on recurring earnings in 2018, compared with 62% in 2017 and 63% in 2016, and from an average of 77% between 2010 and 2015. According to JE, Zhendan has commenced operations, and the other three projects are 30%-50% completed. We project these new income streams, along with steady growth on existing toll assets, to drive a recurring net profit CAGR of 6% for JE over the next five years. In addition, with the majority of these projects completing by 2020, we expect JE's free cash flows to improve, underpinning an upside for dividend payout ratio from 2021.