Sector Review:

Asia-Pacific Credit Trends 2014: Transportation Infrastructure Faces Policy Uncertainty; Utilities Deal With High Energy Costs And Green Power
Primary Credit Analysts: Parvathy Iyer, Melbourne (61) 3-9631-2034; parvathy.iyer@standardandpoors.com Thomas Jacquot, Sydney (61) 2-9255-9872; thomas.jacquot@standardandpoors.com

Table Of Contents
For Transportation Infrastructure, Regulatory And Policy Uncertainty Varies Across The Region Sector Outlook Key Risks And Trends Ask The Analyst High Energy Costs And Focus On Green Power Dim Utilities' Prospects Sector Outlook Key Risks And Trends Ask The Analyst Related Research

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Sector Review:

Asia-Pacific Credit Trends 2014: Transportation Infrastructure Faces Policy Uncertainty; Utilities Deal With High Energy Costs And Green Power
(Editor's Note: This article is part of a series on the credit trends of Asia-Pacific's corporate sectors for 2014. The series responds to analytical queries received recently on a sector or a specific issuer in that sector.)

For Transportation Infrastructure, Regulatory And Policy Uncertainty Varies Across The Region
Analyst: Thomas Jacquot

Sector Outlook
The credit outlook for the Asia-Pacific transportation infrastructure sector will largely be stable in 2014, although growth will vary between countries in the region (see table 1). For Australia and New Zealand, we expect moderate economic expansion will continue to support higher earnings and relatively stable financial performance of rated companies. Meanwhile, in China, slower growth in the first part of 2013 and recent policy changes have dampened earnings in the early part of the year. Nevertheless, we expect China's sector to recover in the second half of the year, and that revenue will trend upward modestly in 2014.
Table 1

Asia-Pacific Transportation Infrastructure Sector Outlook For 2014

Business conditions Business outlook Financial trend Sector outlook Satisfactory No change Same Stable

Key Risks And Trends

The key risks for companies in the sector are likely to be related to issues and circumstances concerning each entity, rather than stemming from macro-economic trends. In particular, merger and acquisition (M&A) activity over recent times or large capital expenditure--in both cases funded through more debt--have worsened some companies' financial performance. Given our outlook of gradual economic growth in 2014, we estimate that the recovery for these companies might be slower than originally anticipated. Any economic slowdown, even marginal, could delay that recovery and lead to negative rating actions.

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Sector Review: Asia-Pacific Credit Trends 2014: Transportation Infrastructure Faces Policy Uncertainty; Utilities Deal With High Energy Costs And Green Power

Ask The Analyst

How do you expect Japan's Revitalization Strategy to affect the country's transportation infrastructure sector?
As part of the Japan Revitalization Strategy, the government has announced its intention to develop infrastructure (such as airports and ports) to stimulate economic growth. The strategy will likely focus on greater involvement of private sector companies in the ownership and operations of existing assets. While the actual structure of the ownership and operating model is uncertain at this stage, this strategy is consistent with trends we are seeing in other countries globally and regionally. In our view, the degree of predictability and stability of the regulatory and operating framework that will be implemented will greatly influence the continued stability of the transportation sector during this transition. We believe that certain key drivers for this sector (such as passenger growth for airports or trade volumes for ports) are generally very steady, given the typically significant barriers to entry that temper competition. As such, predictability of revenue, which would be supported by the contractual, regulatory, and legal framework, will be critical to the overall credit quality of the sector. However, too much regulation and fierce competition between airport and land transportation are key hurdles to encouraging private investors. We estimate that most of the domestic airport operations have relatively low profitability compared to other companies in the sector. Consequently, we believe that the central and local government's push for flexible regulation will be key to the successful implementation of the strategy.

Is private-sector involvement in new infrastructure declining in Australia, particularly in light of the New South Wales government's intention to fund certain road projects?
Greenfield road projects in Australia have had a relatively poor track record in recent years. Four of the most recent projects defaulted shortly after opening, primarily because of traffic being materially lower than expected. As a result, debt investors are very reluctant to participate in new greenfield projects, which significantly restricted the use of concessions that incorporate traffic risk. However, there is strong evidence that investors are still keen to finance mature assets given the predictability of cash flows. The New South Wales (NSW) government intends to fund a series of road projects in Sydney on balance sheet. The structure envisaged primarily seeks to put in place temporary funding to cover the construction period until such time as the traffic stabilizes. Once this is achieved, the government intends to issue debt that will be supported solely by toll road revenue, with no recourse to the government. In our view, this long-term financing will have similar characteristics with traditional project finance structures and will likely attract interest from investors already participating in this sector. However, the NSW government faces the initial challenging task of developing the new assets. We believe the state government will ultimately continue to rely on private-sector involvement in operating and funding that sector.

How do you view the policy risk in China's toll road sector?
Chinese toll road operators have been facing heightened policy uncertainty since two years ago, when the government responded to the perceived high toll rates in China and started to clear out the irregularities in this sector. The green

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Sector Review: Asia-Pacific Credit Trends 2014: Transportation Infrastructure Faces Policy Uncertainty; Utilities Deal With High Energy Costs And Green Power

passage policy for waiving toll fees of fresh farm products and the toll-free policy for passenger cars during four national holidays have adversely affected the operators. In our view, policy uncertainty could continue in China until there is a transparent regulatory framework on toll rates and concessions. The government has to balance the lowering of transportation costs, the interests of toll road operators, and the attractiveness of highway construction projects for private capital. China plans to invest about renminbi (RMB) 2.5 trillion on new national highways during 2013-2030. Materially adverse policies are therefore less likely, in our opinion. We expect the credit quality of major toll road operators to be largely stable. Although the holiday toll-free policy since October 2012 has led to revenues reducing by 5%-8% on average, operators are still likely to grow their revenue modestly in 2013-2014. A pick-up in traffic amid an economic recovery in the second half of 2013, and a continued rise in car ownership will support earnings. We view the investment appetite of major toll road operators as less aggressive than before because of higher construction costs and lower returns on new roads.

High Energy Costs And Focus On Green Power Dim Utilities' Prospects
Analyst: Parvathy Iyer

Sector Outlook
The credit outlook for the Asia-Pacific utilities sector is largely stable with a slight negative bias (see table 2). However, we expect some divergent trends between the mature markets of Australia and New Zealand and developing markets of Asia. In Asia, economic conditions are still reasonably good, which will boost industrial output and hence generate strong demand for energy. Moreover, tariffs have increased in many markets in 2013. As a result, we expect revenues and margins to stabilize even if fuel costs were to increase. If governments do not maintain the planned tariff increases in 2014 or seek to reduce tariffs for socio-economic reasons, it will erode utilities' financial headroom and heighten risk in the near term. Idle nuclear capacity in Japan and Korean utilities, and higher costs of alternate forms of generation remain a threat to the cost and profitability of the rated utilities in these countries. In contrast, moderating economic growth, strong competition, and high retail energy prices in Australia and New Zealand are likely to dampen energy consumption. Consequently, effective cost management will be crucial in curbing the financial impact on rated utilities in the Pacific region.
Table 2

Asia-Pacific Utilities Sector Outlook For 2014

Business conditions Business outlook Financial trend Sector outlook Satisfactory No change Stable to slightly negative Stable to slightly negative

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Sector Review: Asia-Pacific Credit Trends 2014: Transportation Infrastructure Faces Policy Uncertainty; Utilities Deal With High Energy Costs And Green Power

Key Risks And Trends

The key risks for Asian utilities remain access and cost of fuel, stability of tariff paths, and utilities' ability to recover costs and generate adequate returns on their new investments. In addition, rated utilities' expansion strategies will influence their credit quality. Capital investment in new plant capacity and expansion/replacement of networks and inefficient units remain large in Asia to meet forecast high demand, and we expect some rated entities will continue to seek offshore opportunities. Moreover, utilities' focus on green energy and continuing uncertainty on nuclear strategy in some countries are likely to influence the life of existing plants and new investments, particularly in China, Taiwan, Korea, and Japan. In the Pacific market, we expect strong competition in the unregulated energy market amid weak demand to pressure company finances. Increasing renewable energy generation will continue to depress wholesale prices, making cost management increasingly important for companies. Furthermore, excess supply and uncertainty over the Australian government's carbon policy mean the capital investment trend is at its lowest point and unlikely to change in 2014. The regulated utilities are also likely to experience flat or declining negative volumes that may restrict any financial improvements. Nonetheless, most rated regulated utilities in Australia have financial headroom to withstand the soft demand trend while undertaking their regulatory-approved capital expenditure.

Ask The Analyst

What is the potential impact of the evolving policy landscape for Asia-Pacific utilities?
Evolving policies around reducing carbon emission levels, renewable energy targets, use of nuclear plants, and future investments present short-to-medium term risks to most Asia-Pacific utilities. In the short term, the key risk is their ability to manage transition risk, while in the medium-to-long term, it is about investment trends and realigning their portfolio mix. In China, more investment is directed toward hydro, solar, nuclear, and wind plants, with numerous projects underway. Approval of new nuclear projects signals the government's determination to use nuclear power as an effective means to achieve its target carbon emission reduction. While tariff policies for such projects are becoming more transparent and benchmarked to coal-fired plants, the track record is short. The ability of entities to secure adequate returns on investments will be an important factor for their credit quality. In Japan, uncertainty continues on whether nuclear plants are the preferred option. Tariff increases have been small, and the quantum may not be adequate to restore profitability of rated entities to levels seen prior to the Fukushima disaster. If the nuclear plants are turned off, the high costs of alternate fuel and replacement of nuclear capacity would present additional risks to the sector. In Australia, uncertainty on carbon policy has heightened risk for investment in new projects. We think a strategic change in the mix of plants and new investment would be required over a shorter time frame to attain the current renewable energy target. However, excess generation relative to demand and limited financial headroom of the rated entities may restrict their ability to undertake new investments in the near to medium term at their current ratings.

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Sector Review: Asia-Pacific Credit Trends 2014: Transportation Infrastructure Faces Policy Uncertainty; Utilities Deal With High Energy Costs And Green Power

What are the potential risks from the high investment trends by Asian utilities?
The key potential risks are inadequate tariff adjustments (timing and quantity), volatile fuel costs, subdued demand than projected, and utilities' inability to manage costs. Large investments are underway in most Asian markets--namely Korea, Taiwan, China, India to name a few--predicated on forecast demand and to build reserve margins. While favorable tariff adjustments have occurred during 2013 in most markets and are expected to be maintained, the track record in this respect has not been favorable and predictable. In addition, volatile fuel prices (mainly coal, gas, and liquefied petroleum gas) and economic sensitivity to energy prices could affect the cost base of utilities and restrain improvement in financial profile. A favorable factor for most Asian entities is the low interest rate regime, which is supporting their financial metrics in the near term.

How do we view the changing ownership of utilities in Australia and its impact on credit quality?
Offshore ownership in Australia's regulated utilities is not uncommon, and we would expect this trend to continue if more state-owned assets are privatized in the medium term. We expect continued strong interest from Chinese, Canadian, and Hong Kong entities/investors as they target growth opportunities outside their core markets, particularly in the regulated space with annuity-style returns. With the regulator focusing on cost efficiency and efficient parameters for regulated utilities in Australia from 2015, we believe shareholder expectation and behavior in the lead-up to 2015 will have an important bearing on a utility's credit quality. Besides policies, we also look for the owner's track record with respect to the management of assets, debt refinancing, and liquidity. Potential impact on credit quality is likely to stem from financial management rather than structural changes. At this stage, we do not anticipate any adverse impact on the credit quality of regulated Australian utilities due to ownership changes. While we expect offshore investors in Australian merchant utilities, the price tag may not be high as seen in the past. The New South Wales government is looking to sell its remaining merchant plants: Macquarie generation (about 4500 megawatts [MW]) and Delta Coastal (about 1300 MW). The age of these assets and fuel base (mainly coal), increasing penetration of renewable energy, and softening demand make the sector less attractive for returns or stability.

Related Research
Asia-Pacific Credit Trends 2014: Still Robust Domestic Growth and Steady Financial Profiles Underpin Our Mostly Stable Outlook On Indonesia's Corporate Sector, Oct. 30, 2013 Asia-Pacific Credit Trends 2014: Middle Classes Fuel Consumer Products; Retail To Keep Doing It Hard; Gaming On A Roll, Oct. 30, 2013 Asia-Pacific Credit Trends 2014: Real Estate Developers Wrestle With Regulatory Curbs; REITs Hunt For M&As, Oct. 29, 2013 Asia-Pacific Credit Trends 2014: Tech Firms Focusing On Asia And Smart Devices Will Outperform, Oct. 28, 2013 Asia Pacific Credit Trends 2014: Telcos Look To The Cloud In Search Of Growth, Oct. 27, 2013
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