Off the Rails

Default by a railway materials supplier would be a test case for the over-leveraged industry.

Another day, another Chinese company with debt troubles. This one is worthy of more attention than usual, though.

On Monday, China Railway Materials Commercial Corp. halted trading on 16.8 billion yuan of bonds ($2.6 billion) as it studies how to repay debt and turn around the business. The trader of steel and other rail supplies joins a host of companies in China that have been struggling to repay bonds, with at least a dozen having defaulted in the past couple of years. The fact that this one is state-owned and operates in the railway construction business makes it special.

The outcome could be a sign of how China will deal with one of its most indebted and economically important sectors. The country's railway companies have 1.4 trillion yuan of bonds outstanding, including $2.6 billion of dim sum and dollar securities.

Investors have been buying debt from rail companies, especially China Railway Construction Corp., as if they were government issues. China Railway Construction's debt has more than doubled over the past five years to 187.2 billion yuan, while several other financial health metrics have deteriorated. The company had total debt that was equivalent to 145 percent of its equity at the end of 2015. 

Fast Track

China Railway Construction's debt has more than doubled in the past five years

Source: Bloomberg

Those numbers would be more commonly associated with high-yield companies. Yet China Railway Construction's dollar bonds maturing in 2023 trade at a yield of 3.3 percent, or a 153 basis points premium over U.S. Treasuries. China's government doesn't have any dollar bonds, but the country's credit default swaps sell at a spread of 123 basis points, which suggests that its main railway construction company is treated effectively as a proxy for the Ministry of Finance.

High Speed Leverage

While it has dropped recently, the debt to equity ratio of China Railway Construction is still at 145 percent

Source: Bloomberg

That's why a potential default by China Railway Materials would be scary. The company isn't directly related to China Railway Construction, though they share a common owner in the State-Owned Assets Supervision and Administration Commission. Given the similarity in the names, ownership and area of operations, investors could be forgiven for feeling skittish over the former's financial difficulties.

Ticket to Build

Debt issued by China's railway companies has surged since the global financial crisis

Source: Bloomberg

China Railway Materials could be a test case for where China draws the line in support of state-owned companies that have piled on debt. Three have already defaulted onshore. All were in industries considered either less important or in need of a clean-up. Baoding Tianwei Group is a renewable energy company, while Sinosteel and Chinacoal Group Shanxi Huayu Energy are in sectors where the government has indicated it wants to reduce excess capacity.

None of the three had any foreign debt. In the case of railways, investors from Hong Kong to London have gladly bought about $2.6 billion of bonds seen as carrying Chinese government backing, betting that the nation's ``One Belt One Road" policy will outweigh any leverage issues. The pain may spread many kilometers from Beijing if the government chooses to let China Railway Materials default.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

    To contact the author of this story:
    Christopher Langner in Singapore at

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    Matthew Brooker at

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