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April 4 (The following statement was released by the rating agency)
Fitch Ratings has downgraded China-based Yanzhou Coal Mining Company Limited's (Yancoal) Long-Term Issuer Default Rating (IDR) to 'BB+' from 'BBB-'. The Outlook is Stable.
Fitch has also downgraded the rating on the dual tranche USD1bn notes issued by Yancoal International Resources Development Co., Limited and guaranteed by Yancoal, to 'BB+' from 'BBB-'.
Fitch revised Yancoal's Outlook to Negative from Stable in May 2013 to reflect the company's weakened credit metrics due to the deteriorating coal market conditions since 3Q12. Today's downgrade of Yancoal's ratings stems from our view that coal prices will remain subdued for an extended period and Yancoal's ability to further curtail operating costs is limited. Furthermore, the proposed changes to coal resource taxes in China may have additional negative implications on margins. These factors will result in weak credit metrics over the next 24 months, although we expect Yancoal to generate positive free cash flows post-2014 allowing it to gradually improve its credit profile. Yancoal's still strong liquidity continues to be a positive factor. However, there is little headroom under the revised ratings.
KEY RATING DRIVERS
Coal Market Under Sustained Stress: The deteriorating coal market conditions have drastically weakened Yancoal's credit metrics. 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 (end-2012: 4.5x), and FFO adjusted net leverage to 6.1x (end-2012 3.9x).
China's coal price has dropped to the lowest level since end-2008 and Fitch does not expect market conditions to meaningfully improve in the short-term. The coal market is still oversupplied with low cost imports and heated price competition among China's large domestic mining companies. Furthermore, coal demand is likely to remain sluggish given the overall deceleration in China's industrial sector growth, increasing share of renewable capacity in power generation and policy headwinds from China's initiatives to reduce environment pollution, especially in eastern China, including regions where Yancoal's mine are located.
Negative Impact from Resource Tax: Fitch expects the new price-based resource tax on coal mining - instead of a volume-based tax previously, which is likely to be adopted in the near term, can exert further pressure on domestic coal producers. The tax burden, expected to be around 5% of the selling price, is roughly five times that of the current volume-based tax. While it is expected that some other taxes can be netted off against the higher resource tax, it will still increase the overall tax burden on the sector. However, we expect this could accelerate market consolidation by squeezing out smaller, weaker players, which could benefit larger miners such as Yancoal in the longer term.
Cost Cuts Helped, But Further Savings Challenging: Fitch recognizes Yancoal's efforts in cost savings during the market downturn. In 2013, average cost of sales of Yancoal's domestic mines fell by 15% in addition to the 11% drop in selling, general and administrative expenses (SG&A). This result was achieved through production system optimization, and labour cost and workforce cuts.
Fitch expects a good proportion of these benefits to be sustainable in the medium term; however, opportunities for further cost savings are very limited. Capex to Trend Down After 2014: Yancoal's capital expenditure was as high as CNY9bn to CNY10bn per annum in 2012 and 2013 - mainly to develop new coal mines in Australia and Inner Mongolia, and 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 has not constrained Yancoal's rating. Yancoal's large number of institutional minority shareholders and the Hong Kong Stock Exchange listing rules provide a meaningful counter-balance to Yankuang's controlling stake. Furthermore, 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. It had cash balances of CNY10.9bn at December 2013 which offer a strong buffer to its short term debt of CNY11.3bn and nearly half of its debt has maturity of over five years.
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 net FFO adjusted leverage to or below 4x on a projected basis post 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 weak coal prices sustained or a sustained further weakening of coal prices
- Any acquisitions that lead to a further deterioration of 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.