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July 21 (The following statement was released by the rating agency)
Fitch Ratings has affirmed city piped gas distributor China Resources Gas Group Limited's (CRG) Long-Term Issuer Default Rating (IDR) at 'BBB+' with a Stable Outlook. Simultaneously, CRG's senior unsecured rating is affirmed at 'BBB+'.
CRG's IDR incorporates a one-notch uplift for potential support from its immediate parent, China Resources Holdings Limited (CRH), which owns 64% of CRG. CRH is wholly owned by the State Assets Supervision and Administration Commission (SASAC) of China (A+/Stable). CRG's stand-alone 'BBB' rating reflects its diversified operations, its strong credit metrics and liquidity, robust industry fundamentals as well as risks associated with the city gas industry in China.
KEY RATING DRIVERS
Strong Operating and Financial Performance: CRG's operating performance continues to be strong, supported by increasing gas sales and new connections. In 2013, its revenue rose 64% to HKD22.3bn and EBITDA increased 71% to HKD3.8bn. City gas concessions increased to 176 at end-2013 from 151 a year earlier with connected residential users up 31% to 18.4m and commercial & industrial (C&I) users up 14% to173,956. CRG continued to be the largest piped gas distributor by volume in China, supplying 12.1bn cubic meters of gas in 2013, up 30% over 2012. In addition, the company has been increasing ownership and control over a number of concessions. As a result, the previously equity accounted concessions in Wuxi and Jining were fully consolidated into the company's financial results in 2013. The revenue and EBITDA growth in 2013 partly reflects the consolidation of these businesses, which accounted for about 10% of 2013 gas sales.
Robust Credit Metrics: Fitch expects CRG's capex to remain elevated in the medium term as it continues to invest in expanding its city gas operations more aggressively than some of its peers. Nevertheless, Fitch expects CRG to have positive free cash flows before acquisition spending, supported by strong gas sales and connection revenue growth. Barring any material increase in investments or cash returns to shareholders, CRG can further improve its already robust credit metrics. Fitch expects funds flow from operations (FFO) to net adjusted debt to remain comfortably below 2x (2013: 1.6x) and FFO fixed charge coverage to rise above 6x within the next 12-18 months (2013: 5.2x).
Ability to Pass Through Costs Broadly Intact: In June 2013, China's National Development and Reform Commission (NDRC) announced a new pricing mechanism for non-residential users in a step towards liberalised pricing. This effectively raised the average city gate price for C&I users by around CNY0.4 per cubic meter or 20%. In less than six months, CRG had passed through the cost increases to 97% of the affected C&I customers by volume, broadly maintaining the dollar margin on gas sales. In March 2014, the NDRC said a tiered natural gas pricing for residential users would be adopted nationwide before end-2015, which would pave the way for higher tariffs for the residential sector.
Based on the pricing changes for C&I customers, Fitch does not expect a material contraction in profitability of gas sales even with further potential city gas gate price increases in the next two to three years. Fitch, however, expects CRG's overall profitability to decline because the high-margin gas connection revenues will fall as a proportion of total revenues as the businesses mature. This is not a credit negative as gas supply revenues are a more sustainable long-term source of cash generation than gas connection revenues.
Changes to Accounting Standards: CRG started in 2013 to report its results under the Hong Kong Financial Reporting Standard 11 (HKFRS 11), which has stricter requirements for consolidation of jointly controlled entities (JCEs). Before this, CRG's many JCEs were proportionately consolidated into its financial statements. The revised financial presentation does not impact Fitch's credit view on CRG because the agency had fully incorporated the credit concerns from the high number of JCEs as well as the mitigating factors - over 90% of total debt was raised at the holding company level and CRG's strong access to sources of funds - into CRG's ratings. At the same time, the company has been increasing its control over key JCEs, which is a credit positive in the medium term.
Risks in Strategic Options: CRG reported positive FCF (before M&A expenses) in 2013 and Fitch expects CRG will continue to accumulate cash before acquisitions, assuming maintenance capex and dividend payouts remain stable and industry economics continue to be favourable. CRG aims to use its cash reserves for acquisitions, including increasing control over existing concessions, but Fitch expects the company will have substantial cash balances that can be also deployed for other investments. CRG, and other leading city gas operators with positive FCF and large cash balances, may explore other strategic options if opportunities to acquire more city gas projects become more limited. As such, Fitch will seek clarity on the use of such cash balances before the agency takes positive rating action, even if these entities meet positive rating guidelines based on net financial leverage and interest coverage.
Positive: Future developments that may collectively lead to positive rating actions include:
- FFO adjusted gross leverage lower than 3x and FFO fixed charge coverage higher than 6x, on a sustained basis
- FCF after capex, acquisitions and dividends at least reaching broadly break-even on a sustained basis
- clearer regulatory regime, continued demonstration of the company's ability to pass through costs increases without materially affecting margins, and the overall business risk profile not weakening due to investments outside of the city gas distribution business
Negative: Factors that may, individually or collectively, lead to negative rating action include:
- FFO adjusted net leverage higher than 4x on a sustained basis
- FFO fixed charge coverage lower than 4x on a sustained basis
- Expansion into non-city gas businesses that will materially change the company's business risk profile
- a material deterioration in the regulatory environment or worse than expected weakening of profitability of the city-gas distribution operations, which may arise from not being able to translate higher gas procurement costs into higher tariffs
- weakening of the effective linkages with parent, China Resources Holdings Limited/ SASAC