Summary: Lujin Infrastructure proposed a spin-off of the expressway business. We think this is a wise move that will help the company release value. In the past, the value of the expressway business has not attracted investors' attention. One reason is that the business's profit share is relatively low, and its 2016 profit accounted for only 23% of the segment's profit. According to conservative assumptions, if Lujin Infrastructure's road business valuation catches up with peers after the spin-off, there will be room for shares to rise 9%. We even think it's not difficult for the company to record a double-digit increase, because about 51% of its 2016 highway and toll road revenue came from Hebei, so for mainland investors, the company's highway business may have the Xiong'an concept and is expected to receive a higher valuation. Currently, Lujin Infrastructure's price-earnings ratio in 2016 is 5.87 times, and the dividend yield is 6.9%.
Highlights of the spin-off: (i) Lujin Infrastructure submitted an application to the Hong Kong Stock Exchange to spin-off and list its shares (expressway business). The proposed spin-off is expected to be implemented in the form of a global offering and independent listing of Ventou's shares on the main board of the Stock Exchange. The bill is subject to shareholders' approval at the Extraordinary General Meeting of Shareholders; (ii) It is proposed that after the spin-off is completed, there will be a clear division between property and highway business. By the end of December 2016, Jintou Group's expressway portfolio included interests in five expressway projects, with a total network coverage of about 340 kilometers. Its highways are located in four provinces of China: Anhui, Hebei, Hunan and Shanxi; (3) the total net proceeds from the global sale will be used mainly for the acquisition of new expressway projects and the expansion of plans for existing expressway projects; (iv) if the proposed spin-off is carried out, the company plans to provide guaranteed quotas for Lujin Infrastructure shareholders through priority applications for a global sale (the terms of the relevant guarantee quotas will be announced in due course); (v) the proposed co-sponsors of the listing are J.P. Morgan Securities (Far East) Co., Ltd., HS and BC Star Asia Finance Co., Ltd.
The net market ratio of the expressway business is expected to double. According to the announcement, the net profit after tax (fiscal year 2016) and net consolidated asset value (end of 2016) of Jintou's continuing operations were HK$388 million and HK$4,501 million respectively, representing a return on equity of 8.6%. We have noticed that the price-earnings ratio of Hong Kong-listed expressway companies in 2016 was 0.7 times - 2.0 times. The stock prices of Shenzhen Expressway Co., Ltd. [0548.HK] and Anhui Wantong Expressway [0995.HK] were both slightly higher than their net assets per share, and the return on equity reached 9.2% and 9.6% respectively. Therefore, judging from the return on equity of Strong Investment, we think its net market ratio is expected to double.
Investors may give a premium because of the “Xiongan” concept. In 2016, about 51% of its revenue came from Hebei, making Jintou a relatively pure “Xiongan” concept stock. If the market atmosphere is good at the time of the company's spin-off, we do not rule out that investors (especially investors from the mainland) may be willing to give the shares a premium (that is, a net market ratio greater than 1 times).
There is an opportunity to record double-digit gains as a result of the spin-off. The current market value of Lujin Infrastructure is HK$7.34 billion, representing a net market ratio of 0.55 times (net assets as of the end of 2016 were HK$13.3 billion). Assuming that its net market ratio doubled at the time of listing (i.e. HK$6 billion, assuming that the number of new shares accounted for 25% of the total number of shares), the value of the property business was only HK$4.19 billion (assuming a 30% discount from the holding company of VIC after the spin-off), far below the book value of the property business of HK$8.8 billion. If we conservatively assume that the property business will not be revalued (about 0.55 times net market ratio), the fair value of Lu Jin Infrastructure would be HK$7.99 billion, representing room for growth of about 9%. We think stocks will easily have room for double-digit gains. For example, if the net market ratio of Strong Investment is 1.2 times, then the fair value of Lujin Infrastructure is HK$8.6 billion, which represents a margin of increase of 17.6%. If the property business is re-valued, the upside will be higher. Meanwhile, Lujin Infrastructure currently has a dividend yield of 6.9%, which is highly defensive.
After the spin-off, Lujin Infrastructure's balance sheet was more stable. The final structure of the proposed spin-off, including the scale of the global offering and the precise allocation between the Hong Kong public offering and the international offering, is uncertain. According to the announcement, Jintou will continue to be a subsidiary of Lu Jin Infrastructure after the spin-off. Therefore, assuming that 25% of Lujin Infrastructure's equity is sold in the form of new shares based on book value, the net proceeds would be HK$1.5 billion. We estimate that Lujin Infrastructure's net debt-to-equity ratio will drop from 67.8% to 51.8%.
