Fitch Ratings has revised the Outlook on Hong Kong-based Kowloon-Canton Railway Corporation's ("KCRC") Senior Unsecured local currency rating to Stable from Negative. At the same time, Fitch has affirmed KCRC's ratings at Senior Unsecured foreign currency 'AA-' (AA minus), Short-term foreign currency 'F1+', and the Senior Unsecured local currency 'AA'. The Outlook on the foreign currency ratings remains Stable. The Senior Unsecured foreign currency rating is constrained by that of the Hong Kong Special Administrative Region ("HKSAR", rated 'AA-'(AA minus) Stable/'F1+').

The revision of the local currency rating Outlook to Stable reflects Fitch's expectations that KCRC's operating results would improve over the next 18 to 24 months, following the improvement of passenger traffic on its West Rail line, and that there would be no material change in the on-going support from the HKSAR.

Fitch notes that the local currency rating more accurately captures the fundamental credit quality of KCRC, and reflects the on-going support from the government (which has a local currency rating of 'AA+') as well as the underlying revenue generating capacity of KCRC's rail service. KCRC has a close relationship with the government, underpinned by its 100% government ownership and its importance to Hong Kong's public transit regime. The government has been supportive to the company in the past, particularly by injecting equity capital and providing property development rights to finance the construction of new rail lines. Fitch notes that the government has indicated that rail-based transit will continue to be the backbone of its transportation policy, thus the agency does not envisage material reduction of government support to the company.

KCRC's cash generating capacity is strong, with a healthy farebox recovery (the measure of rail operating expenses covered by passenger fare revenue) of 1.75x in 2004 (2003: 2.15x). KCRC's position of being the sole rail connection to Shenzhen, China, and the lack of rail-based competition in most of its service area, will continue to provide good support to its cash generating capacity. This is bolstered by its above average property investment portfolio.

Whilst Fitch acknowledges that KCRC has a sound operating profile, its credit strength is tempered by its massive expansion programme, and to a lesser extent, pressure on profit margins. The total estimated capex requirements in the next five years exceeds HKD22 billion, which is expected to be satisfied by a combination of cash/liquid investments (HKD5.9bn as at FYE04), external borrowings, and internal cash flows. KCRC's funds from operations ("FFO") to adjusted net leverage and FFO to gross interest coverage were 5.4x and 2.8x, respectively in 2004. Fitch anticipates that these ratios will be weakened over the next five years due to the company's capex.

The under-performing West Rail line, which had put pressure on profit margins and tempered KCRC's cash generating capacity when it opened in December 2003, has registered good passenger load growth since mid-2004, though it is still below original forecasts. EBITDA margin improved marginally to 45% in 1H05 (2004: 43.9%) but is still below the 52.2% level achieved in 2003. As KCRC has resumed residential property development activities in 2005, Fitch expects good population growth in its catchment area and passenger traffic to pick up further in the medium-term.

The proposed merger with MTR Corporation Limited ("MTRC", rated 'AA-' (AA minus)/Stable/F1+), which is still under discussion, has not been factored into the ratings as the eventual structure is not yet known. That said, Fitch expects government support for the merged entity to be no weaker than its current form.

KCRC is one of the two rail operators in Hong Kong. It currently operates three passenger rail lines offering domestic, cross-border and intercity services to mainland China. KCRC also has material interests in real estate along its network. KCRC carries over 1.4 million passengers each day and is solely owned by the government.

People's Daily Online