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May 14 (The following statement was released by the rating agency)
Fitch has affirmed Yanzhou Coal Mining Company Limited's (Yancoal) Long-Term Issuer Default Rating (IDR) at 'BB+' and the Outlook is Stable. The rating of the dual tranche USD1bn notes issued by Yancoal International Resources Development Co., Limited, guaranteed by Yancoal, is also affirmed at 'BB+'. Simultaneously, Fitch has assigned Yancoal International Trading Co., Ltd.'s (Yancoal International) proposed US dollar senior perpetual capital securities, which are guaranteed by its 100%-owner Yancoal, an expected rating of 'BB(EXP)'.
Fitch expects to accord no equity credit to the proposed US dollar perpetual capital securities in its evaluation of Yancoal's capital structure and leverage because this instrument ranks pari passu with Yancoal's senior unsecured obligations, it has an effective maturity of less than five years and the deferral of coupon payments is subject to 'look-back' provisions.
The proposed securities are rated one notch below Yancoal's 'BB+' IDR in accordance with Fitch's "Treatment and Notching of Hybrids in Nonfinancial Corporate & REIT Credit Analysis" criteria to take into account their coupon deferral feature. The final rating is contingent upon the receipt of final documents conforming to information already received.
KEY RATING DRIVERS
Additional Short Term Liquidity: Yancoal plans to use proceeds from the proposed bond to refinance debt maturing in the near term and previously planned capex in Australia. The proposed perpetual bond provides additional liquidity to Yancoal to weather the more challenging business conditions and reduces refinancing pressure on the company for the next 12 months. The company had CNY15.5bn (USD2.49bn) of cash and cash equivalents at end-2013 compared with the total short-term debt of CNY11.3bn (USD1.81bn). The proposed perpetual bond will add around CNY1bn of cash, after taking into account offshore short-term debts payback and incremental interest costs for the next two years.
Fitch estimates that Yancoal's gross debt will likely increase by approximately CNY1.25bn (USD200m) and annual interest payments will rise by at least CNY110m, which will further weaken the company's credit metrics which already offers very limited headroom at the current rating level. In addition, total secured debt to EBITDA ratio, under the current weak coal price, will remain elevated at around 2.5x.
Weak Market Conditions to Continue: Coal prices in China have dropped to their lowest levels since end-2008. While Fitch expects coal prices to stablise as customers start re-stocking and more of the smaller miners in China close, market conditions are not likely to improve meaningfully in the next 12 to 24 months. In 2013, Yancoal's average selling price dropped 13%, materially weakening its operating cash generation. Funds from operations (FFO) gross interest coverage weakened to 3.7x at end-2013 from 4.5x a year earlier, and FFO adjusted net leverage deteriorated to 6.1x from 3.9x over the same period.
Importance of Cost Controls: Fitch believes cost control is the only lever coal producers still have to weather the weak market conditions over the next two to three years, in the absence of any strong policy support to curb cheaper coal imports.
Fitch recognises Yancoal's efforts in cost savings in 2013, when the company's average cost of sales at its domestic mines fell by 15% and its selling, general and administrative expenses decreased by 11%. Most of its mines continued to achieve cost reduction in 1Q14. These results were achieved through production system optimisation and reductions in labour cost and the workforce. Fitch expects a good proportion of these benefits to be sustainable in the medium term. However, opportunities for further cost savings are very limited.
Negative Impact from Resource Tax: Fitch expects China's new price-based resource tax on coal mining - instead of a volume-based tax previously - to exert further pressure on domestic coal producers. The new tax, which is likely to be adopted in the near term, will probably be around 5% of the selling price.
That means the tax burden for coal miners could be roughly five times that under the current volume-based tax, although in practice the impact would be tempered by netting off other taxes against the higher resource tax. However, we expect this could accelerate market consolidation by squeezing out smaller, weaker players, which would benefit larger miners such as Yancoal in the longer term.
Capex to Trend Down: Yancoal's capital expenditure was as high as CNY9bn to CNY10bn a year in 2012 and 2013, mainly to develop new coal mines in Australia and Inner Mongolia, and for the methanol projects in Ordos. However, these developments will be gradually completed after 2014, following which capex will be confined to maintaining the production level. As such, Fitch expects Yancoal's free cash flow to return to positive after 2014 and its credit metrics to improve, although a return to pre-2012 levels is not expected in the medium term.
Linkages with Parent: Yancoal is 56.5% owned by Yankuang Group Corporation Limited (Yankuang), which is wholly owned by the Shandong State-owned Assets Supervision and Administration Commission (SASAC). The linkage is considered weak to moderate, and therefore, Yankuang's weaker credit profile does not constrain Yancoal's rating. The large number of institutions that are minority shareholders in Yancoal and the rules governing its listing on the Hong Kong Stock Exchange provide a meaningful counter-balance to Yankuang's controlling stake. Fitch has not provided any rating uplift to Yancoal on account of any implied support from the Shandong government. However, Yancoal benefits from good access to sources of funds due to its status as an entity majority-owned by the Shandong government.
Negative: Future developments that may individually or collectively lead to negative rating action include:
- FFO fixed charge coverage lower than 3.5x
- Failure to reduce FFO adjusted net leverage to or below 4x on a projected basis after 2015
- Sustained negative free cash flow after 2014
- Weakening of the sizeable liquidity buffer Yancoal currently maintains with large cash balances, including any increases in dividend payments
- Higher-than-expected resource tax applied and/or less-than-expected netting off allowed for other taxes paid against the higher resource tax
- Higher-than-expected increase in operating costs together with continuation of weak coal prices or further sustained weakening of coal prices
- Any acquisitions that lead to further deterioration of the financial profile
Positive Triggers: We do not expect any positive rating action in the medium term given our expectation of weak market conditions and policy developments that are generally adverse for the sector.