In the past three months, the dividend index has dropped by 11%, while the Shanghai Composite Index has experienced an 8% correction.

It is apparent that the dividend sector has undergone a significant adjustment, with even the largest weighted bank stocks not being spared.

However, it is worth noting that the transportation sector, represented by expressways, has remained resilient during this major correction, with many related concept stocks reaching historic highs. Moreover, this trend has persisted over the past three years.

Why has the market been favoring this sector with individual funds in the past three months?

Among many dividend assets, can the future performance of expressways rival hydroelectric assets represented by China Yangtze Power?

01

According to Wind data, the Shenwan Expressway Index (851731) has gained 9.85% since the beginning of this year, significantly outperforming the Shanghai Composite Index during the same period.

In the past 3 years, the annual growth rates of the index in 2021, 2022, and 2023 were 6.9%, -0.3%, and 17.5% respectively, outperforming the SSE Composite Index for 3 consecutive years.

In terms of individual stocks, Anhui Expressway, Shandong Hi-Speed, and Jiangsu Expressway are the top three performers this year, with increases of 51.91%, 45.09%, and 44.29% respectively. Guangdong Provincial Expressway and China Merchants Expressway also have growth rates of over 30%, with 65% of stocks in this segment having positive returns.

If we extend the timeline, the growth rates of many highway stocks are even more astonishing.

For example, since January 2020, Anhui Expressway has accumulated a growth rate of about 250% in a little over 4 years, while Shandong Hi-Speed has risen by 163.52% during the same period. Guangdong Provincial Expressway A has a cumulative growth rate of 84.89%, China Merchants Expressway has grown by 74%, and Jiangsu Expressway has risen by 61.83%.

The aesthetic appeal of high dividend stocks is based on several criteria: 1) low valuation, 2) high dividend ratio, and 3) a solid performance foundation. However, the dividend yield of many high dividend targets in various industries has become lower as a result of the initial wave of increases at the beginning of the year. These stocks also have certain flaws in their business models and cannot guarantee a sustained and stable dividend output. Therefore, fund managers are becoming more selective and demanding in choosing dividend assets, making it difficult to identify truly outstanding options.

The business model of highway companies is very simple and transparent: borrow money to build roads in the early stage, and then collect rent to repay the debt in the later stage. At first glance, it is somewhat similar to the model of building hydropower stations. As long as the initial investment is in place, there will be a continuous stream of cash inflow over a long period of time.

Moreover, the industry itself has a certain degree of monopoly, with clear pricing standards and regulatory control. The fluctuations in enterprise operations caused by macroeconomic factors are much smaller than many other industries.

Therefore, the performance of listed highway companies has stable support. Even if other conditions change, such as frequent extreme weather in the first half of the year and an increase in toll-free passage time, the performance of listed companies will not experience a significant decline.

Secondly, the toll collection period for expressways is as long as 25-30 years, and after the assets enter the stable period, they provide a guarantee of stable dividend income for a considerable period of time. In the past three years, companies such as Guangdong Provincial Expressway Development, Anhui Expressway, Shandong Hi-Speed, China Merchants Expressway Network Technology Holdings, and Jiangsu Expressway have maintained a high dividend payout ratio and continuous improvement.

Furthermore, considering that the major controlling shareholders of listed companies in the expressway sector are local transportation investment companies or state-owned enterprises, they have a high demand for funds and have the motivation to require listed companies to maintain high dividend payouts. With the introduction of the valuation and estimation system, stricter requirements for market capitalization of state-owned enterprises are expected to further promote the increase in dividend payout ratios of listed companies.

In the transportation sector, compared to other sectors, the valuation and profitability of high-speed highways are more advantageous. Although the current price-to-earnings ratio of expressways at 13 times is not particularly low, its profitability is among the best in many segmented industries, as seen from the net margin in the interim report.

From the market performance perspective, the market trend of the expressway sector is mainly triggered by two factors: capital structure and decline in overall yield.

Starting from mid-2020, there has been an evident negative correlation between the sector and the CSI 300 Index. In other words, when the overall market index performs poorly, the expressway sector gradually attracts capital. Due to its bond-like characteristics, in a market environment with a high risk premium, as the proportion of long-term funds entering the market increases, there is an expanding demand for bond-like assets.

Since August 2023, the policy has vigorously promoted the entry of medium and long-term funds into the market, including relaxing restrictions on insurance funds and pension fund stock investments, and increasing the scale of equity investment. The highway sector has also received long-term capital favor, such as the continued increase in shareholding of Ganyue Expressway by Changcheng Life Insurance in the first half of the year. In the first half of this year, it has ranked second with a shareholding of 6.18%, but it was not among the major shareholders last year.

On the other hand, the continuous decline in the yield of 10-year government bonds indicates that the market's risk appetite and the potential investment return rate of the whole society are both decreasing, and the demand for liquidity in investment and financing is insufficient. In such an environment, the difference between dividend yield and the yield of 10-year government bonds has enlarged the defensive property of the highway sector, making it able to attract funds to avoid risks in periods of high uncertainty.

Not only their stocks, but also REITs attract funds.

This relatively novel investment product for individual investors has been listed for more than three years. It is a fund that raises funds from investors to invest in real estate and infrastructure projects, and distributes investment income. According to the dividend regulations, more than 90% of the annual distributable amount should be distributed to investors.

For example, the China Yangtze Power REIT issued by China International Capital Corporation and Shandong High-Speed Company in October last year raised 2.985 billion yuan for the Shandong Juhe Haishi project. Up to now, the cumulative dividends have reached 1.1224 yuan per share, and based on the current average net asset value on the benchmark date, the dividend yield is as high as 16.10%. The transaction value in the secondary market has increased by about 2 yuan from the lowest price of 5.366 yuan, with a growth rate of nearly 40%.

02

From an industry perspective, the current domestic expressway has entered a stage of high inventory and low growth.

By 2022, the total mileage of expressways in China has reached 0.1773 million kilometers, with a compound annual growth rate of 5.4% in the past decade. Most provinces in eastern and central China already have mature and highly dense expressway networks, with future construction focusing mainly on the western region, where there is considerable room for improvement in expressway density.

As infrastructure, the companies involved in the construction and operation of expressways are mostly controlled by provincial state-owned assets and are controlled in terms of quantity through franchise operation, creating certain policy barriers. In addition, expressway construction requires large capital investment and has a long payback period, giving private enterprises no advantage in long-term financing channels, thereby minimizing industry competition to the greatest extent.

However, due to the influence of regional economic factors, economically developed areas typically have a high density of expressway networks, high node value, and a wider natural upper limit of traffic flow. Regions such as Beijing, the Yangtze River Delta, and Guangdong have significantly better revenue generation capabilities per kilometer, giving enterprises such as Guangdong Provincial Expressway Development and Jiangsu Expressway a more prominent market position under this special competitive advantage.

From a business model perspective, the main source of income for expressway enterprises is toll fees, which can be broken down into traffic volume multiplied by fees per unit distance multiplied by total distance.

Among them, the fee per unit distance is the least elastic as it is subject to strict control by local governments. This fee standard should consider factors such as the technical grade of the expressway, total investment, local price index, loan repayment period, and traffic volume. In general, developed areas and high-cost sections should have slightly higher toll levels.

However, to alleviate the repayment pressure after operation, local governments will at least ensure a reasonable price level, such as setting it at the breakeven point on certain low traffic density sections. In general, profitability is usually favorable for sections with high traffic density.

In addition, after the expansion of the expressway, in order to cover the increasing land and labor costs, there is also reason to consider raising the toll standards. In the future, as renovation and expansion become the main form of investment for highway companies, it will bring some growth space to the company's income to a certain extent.

Compared to prices, the stable traffic flow is more needed for the company's performance. Traffic flow can be divided into passenger and freight traffic. The former is mainly influenced by the number of automobiles and residents' willingness to travel, while the latter is more closely related to the economic cycle.

As an indicator that can be observed daily, we found that traffic flow fluctuated repeatedly during the period of 2020-2023 due to the impact of the epidemic. However, in the long run, traffic flow is expected to recover to a slight growth trend before the epidemic, and even in some highway enterprises, the traffic flow on certain sections managed by them has already exceeded that of 2019.

The favorable trend has actually been reflected in last year's annual report, with ROE and gross margin showing an upward trend.

03

The sustainable operation capability of highway assets is the basis for stable dividends, which is not only affected by the cyclical fluctuations of volume and price, but also depends on the time that assets can be operated sustainably.

Different from government-funded roads, the roads operated by highway enterprises are called commercial highways, which are actually a kind of franchise right. The company builds, collects fees and supports itself. However, after the operation period, it needs to be transferred to the government, unless there is a need for reconstruction during the period, the period can be extended appropriately, but generally not more than 30 years.

The current remaining operation period of listed expressway companies is around 12 years on average. If the future franchise period for new construction and expansion can be extended, it will undoubtedly be a major bullish factor for performance sustainability.

It is gratifying for investors that the new industry policies have opened up new ground. In China, the "Regulations on the Management of Toll Roads" have been revised in 2015 and 2018, requiring the operation period to match the debt repayment period. For high-speed highways with large investment scale and long return cycles, the franchise period of more than 30 years can be agreed upon.

From an investment perspective, companies with more expansion projects are expected to have more flexible future performance, such as Guangdong Provincial Expressway Development and Anhui Expressway.

In the long run, although highways are a stable cash flow business, the valuation compared to China Yangtze Power, which has a valuation of more than 20 times, still has some disadvantages.

Although extending the toll collection period after expansion and reconstruction is a major bullish factor, it may be affected by the competition and diversion of traffic between highway assets. For example, the successive opening of the Hui Long Expressway and the Guan Fan Expressway, will it lead to a decrease in the traffic flow of Guangdong Provincial Expressway Development's Guanghui Expressway, and therefore reduce toll revenue?

Moreover, hydropower assets have the lowest cost of electricity generation among various energy sources. Although they are subject to seasonal fluctuations, their power generation capacity is always stable and reliable, which establishes our country's reliance on hydropower for power generation.

However, there are plenty of alternative transportation options for roads, including shipping, water transport, high-speed rail, and subway, in addition to truck transportation. People's travel methods and preferences do not rely heavily on roads. The proportion of road freight volume has remained at more than 70% for many years, and there is not much room for further growth.

Secondly, the franchise period can be extended for charging through expansion and renovation, but there is always uncertainty for the market. A business with a long-term sustainable operation problem often does not receive a high valuation from the market.

Moreover, if it is returned to the government after the deadline, and if it can continue to operate in a commissioned management mode, transforming into a similar role to a property company, it may have the potential to shift to a more light asset operation mode. Although there may be some valuation advantages, the scale of income and profit may be greatly reduced.

Overall, high-speed highway enterprises with a valuation maintained at around ten times will continue to be favored by large funds. This is especially true in the phase of declining market risk appetite. However, just like once-collapsed collective assets, when the price reaches a high trading multiple, compare it with China Yangtze Power and think about why the market is willing to give such a high valuation. (End of the full text)