Key Takeaways
- We have factored into our assessments of railway companies our assumption that post-pandemic passenger demand will not recover fast.
- Railway transportation revenue will likely remain under pressure for the next two years or so, hurting the profits of JR East and JR Central.
- JR Central is likely to recover sooner than JR East and JR West because it started expanding its business base first.
The aftermath of the pandemic will be testing for Japanese railway companies. However, we believe they are equipped to weather the challenges ahead.
S&P Global Ratings lowered by one notch to 'A+' its long-term issuer credit ratings on East Japan Railway Co. (JR East) and Central Japan Railway Co. (JR Central) in the summer of 2020 as railway transportation revenue plummeted amid the COVID-19 pandemic. We also revised our outlook on JR Central to negative from stable in November 2020, and that on JR East to negative from stable on May 31, 2021. We based the revisions on our view that demand for domestic travel will take time to recover, as will the companies' revenue. Below, we answer some frequently asked questions about possible rating changes and key focal points for our analysis.
Frequently Asked Questions
What are your assumptions regarding the impact of the pandemic on Japan's major railway companies?
We expect revenue from railway transportation will remain under pressure for the next two years or so. Demand for business trips will likely take longer to recover than for leisure travel, in our view. In our assumptions, JR East's and JR Central's railway transportation revenue in fiscal 2021 (ending March 31, 2022) will likely be about 70%-80% of what it was in fiscal 2019, and about 80%-90% of the fiscal 2019 figure in fiscal 2022.
The two companies' profits are likely to stagnate for the next two years or so, even though they have significantly cut expenses on maintenance, outsourcing, and personnel. JR East reduced costs by ¥145 billion and JR Central by ¥78 billion in fiscal 2020--the equivalent of 8%-9% of revenue in both cases. They plan to further reduce costs in fiscal 2021; JR East by about ¥70 billion and JR Central by about ¥36 billion. However, the fixed costs of railway operations will continue to weigh heavily on the companies. In addition, demand for leisure travel is likely to recover only moderately over the next two years, in our view.
Of Japan's three major railway companies, JR Central is most likely to make a prompt recovery, in our view. Its core bullet train business is highly profitable. Moreover, JR Central began strengthening its earnings base ahead of its peers, before investing heavily in its Chuo Shinkansen maglev project, initiated in 2014. The company has increased the number of Tokaido Shinkansen bullet train services and started using new, highly competitive cars. It also increased spending in areas such as its online reservation system and ticketless boarding. We believe these measures led to JR Central suffering the smallest operating loss of the three companies in fiscal 2020. Furthermore, JR Central's guidance for a ¥215 billion operating profit in fiscal 2021 substantially exceeds peers'--¥74 billion at JR East and ¥12 billion at West Japan Railway Co. (JR West). Its operating margin is also considerably higher at 17.4%, compared with 3.2% and 1.0%, respectively.
Table 1
| Earnings Of Major Japanese Railway Companies | ||||||||||
|---|---|---|---|---|---|---|---|---|---|---|
| Fiscal 2020 | Fiscal 2021* | |||||||||
| (Bil.¥) | Sales | Operating profit | Sales | Operating profit | ||||||
| JR East | 1,765 | (520) | 2,326 | 74 | ||||||
| JR Central | 824 | (185) | 1,234 | 215 | ||||||
| JR West | 898 | (246) | 1,258 | 12 | ||||||
| *Company estimates. Source: S&P Global Ratings; based on company disclosures. | ||||||||||
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Will you review its industry risk assessment for railway operations, assuming demand for business travel and commuting will not fully recover even after the pandemic?
We are unlikely to review our industry risk assessment for railway operations. In January 2021, we published the results of a partial review of our industry risk assessment which incorporated environmental, social, and governance (ESG) factors, including the impact of the pandemic. The review covers about 40 industries in the corporate and infrastructure sectors. Following the review, we continue to assess the transportation infrastructure sector as having low risk, the second-lowest of six categories in our industry risk assessment. This reflects our view of the unchanged solid business bases of major rail companies and the low likelihood of a pandemic of similar severity as COVID-19 occurring. Our views on the prospects for profit margins, substitution risk of services, and growth trends also remain unchanged. Consequently, we see a limited likelihood of making a downward revision to our business risk assessment of JR Central and JR East.
What is your view of JR East's strategy of expanding into nonrailway operations such as retail and real estate?
We may take more cautious approach in our analysis of JR East's cash flow stability if its revenue becomes more volatile because of an expansion of nonrailway operations. In our view, JR East's cash flow generation is currently more stable than peers' thanks to the balance of its businesses. We believe the company's retail and real estate businesses are highly competitive, backed by its ability to develop and manage stores and the prime locations of its facilities, which are near railway stations.
However, revenue from JR East's nonrailway businesses is less stable than that of its railway operations, in our view. The company has stated plans to generate an equal amount of revenue from the two--the proportions are currently 30% and 70%, respectively. We believe the stability of JR East's cash flow could further decline if there is an increase in the proportion from businesses that are less correlated with its infrastructure railway business. This would occur if the company expands its consumer business through e-commerce or it develops real estate in areas away from stations.
In analytical terms, what is the impact of JR Central's investment in the Chuo Shinkansen maglev project?
We do not see an increased likelihood of JR Central's key financial indicators deteriorating and substantially deviating from our assumptions in the next two to three years. The company announced in April 2021 that the total projected construction cost of the Shinagawa-Nagoya section of the Chuo Shinkansen maglev project would likely be about ¥7 trillion, up by about ¥1.5 trillion from the original figure. The company attributes the increase to construction difficulties and higher costs resulting from enhanced earthquake countermeasures.
JR Central has expressed a willingness to delay construction in order to mitigate the impact on its financial base and maintain financial soundness if necessary. Based on this, we believe the company is highly likely to continue to balance capital expenditures against operating cash flow and debt.
We retain the view that JR Central's earnings will recover after bottoming in fiscal 2020, backed by the strong business base of its core railway operations. Nevertheless, operators face a difficult environment, with repeated declarations of states of emergency to suppress the pandemic. We expect the company's capital expenditures to remain high at ¥700 billion-¥800 billion annually in the next couple of years because of the burden of construction costs for the maglev project. Taking these factors into account, we believe there remains a risk that JR Central's key financial indicators will not recover to levels commensurate with the ratings in the next one to two years.
Related Research
- JR East Outlook Revised To Negative On Slowing Recovery; 'A+' Ratings Affirmed, May 31, 2021
- JR Central Outlook Revised To Negative On Bleak Passenger Expectation; 'A+' Ratings Affirmed, Nov. 6, 2020
- JR Central Downgraded To 'A+' On COVID-19; Outlook Stable, July 3, 2020
- JR East Downgraded To 'A+' As Pandemic Hits Prospects; Outlook Stable, Sept. 25, 2020
This report does not constitute a rating action.
| Primary Credit Analyst: | Katsuyuki Nakai, Tokyo + 81 3 4550 8748; katsuyuki.nakai@spglobal.com |
| Secondary Contact: | Hiroki Shibata, Tokyo + 81 3 4550 8437; hiroki.shibata@spglobal.com |
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