(The following statement was released by the rating agency)
Nov 15 -
Summary analysis -- China Petroleum & Chemical Corp. -------------- 15-Nov-2012
CREDIT RATING: Country: China
Foreign currency A+/Stable/-- Primary SIC: Petroleum
Mult. CUSIP6: 16940D
Credit Rating History:
Local currency Foreign currency
16-Dec-2010 --/-- A+/--
02-Nov-2009 --/-- A/--
The rating on China Petroleum & Chemical Corp. (Sinopec) reflects the company’s strong stand-alone credit profile, which we assess to be ‘a-'. The rating also reflects our opinion that there is an “extremely high” likelihood that the government of China (AA-/Stable/A-1+, cnAAA/cnA-1+) will provide sufficient and timely extraordinary support to Sinopec in the event of financial distress. The company’s business risk profile is “strong” and its financial risk profile is “intermediate”.
Sinopec is the core and most valuable operating subsidiary of China Petrochemical Corp. (Sinopec Group, A+/Stable/--, cnAAA), which is one of the three oil companies in China that the government fully owns. In accordance with our criteria for government-related entities, our view of an “extremely high” likelihood of extraordinary government support is based on our assessment of the following Sinopec characteristics:
-- “Critical” role to the government. Sinopec and its parent play a key role in helping the government ensure a secured supply of energy to meet growing domestic demand. The oil and gas industry in China has very limited private ownership. This solidifies Sinopec’s critical role.
-- “Very strong” link to the government. The Chinese government indirectly owns 100% of Sinopec Group through State-owned Assets Supervision and Administration Commission. Sinopec Group in turns controls about 76.3% of Sinopec. In our view, the government is able to exert a strong influence on Sinopec’s strategy through the appointment of its board members and senior executives and constant surveillance.
Support for Sinopec’s stand-alone credit profile comes from its high degree of vertical integration, diverse assets and revenue streams, and its very strong competitive position derived from its dominant market position in the production and sale of refined petroleum products. The company’s relatively low self-sufficiency in upstream supplies, a low return on its refining business due to government’s intervention on price, and uncertainty over the company’s ability to generate positive discretionary cash flow on a sustainable basis due to very large capital expenditure programs moderate these strengths. The rating also takes into account the parent’s slightly weaker consolidated financial risk profile than that of the company.
Sinopec’s large and highly integrated operations, with its diverse assets and revenue streams, help to mitigate some of the cyclical risks in the industry. The company is the largest refiner in Asia and accounts for about half of the total domestic production in China. While Sinopec’s upstream operation is larger than those of most independent exploration and production (E&P) companies, it is smaller than its international integrated peers’. In addition, Sinopec’s upstream production is significantly below its distillation capacity--its own crude supplies can meet only about 16% of its refining capacity-and therefore the company cannot optimize the integration benefits. The company has stepped up its efforts to increase upstream investments, particularly through the acquisition of overseas assets from its parent. However, we do not expect these investments to materially change the company’s self-sufficiency in crude supply in the next two years.
As inflation eases, the government has adjusted the refined product prices seven times in 2012 without delays. The magnitude of adjustments was pretty much within the specified range. In our opinion, such closely adherence to the adjustment mechanism is positive for refiners in China. It would also be positive for the long-term development of the industry if the implementation of such policy becomes more predictable. Sinopec incurred losses in its refining segment in 2011 and the first half of 2012. But it made an operating profit for the segment during the third quarter of the 2012 following a series of price adjustments.
Despite China’s short-term economic weakness in this year, we believe the country’s strong growth will keep energy demand robust. Under this scenario, in our view, Sinopec Group’s ratio of debt to EBITDA could increase to close 3x for 2012 from about 2x in 2011 due mainly to the weak performance of its refining and petrochemical segments. But we expect the ratio to improve to slightly more than 2x in 2013 as operating conditions improve.
In our view, Sinopec’s liquidity is “strong,” as our criteria define that term. While short-term debt accounts for nearly 31% of its total debts, the amount is manageable for the company. Our assessment of Sinopec’s liquidity profile incorporates the following expectations and assumptions:
-- We expect the company’s liquidity sources over the next 12-18 months to exceed its uses by more than 1.6x.
-- Even if EBITDA declines by 30%, we believe net sources would remain positive.
-- The company has solid relationships with its banks and has a good standing in the credit markets.
In our analysis, we assumed liquidity of about Chinese renminbi (RMB) 249 billion over the next 12 months, consisting of cash, funds from operations (FFO), and available credit facilities. We estimate the company will use about RMB153 billion during the same period, including for our projection of capital spending, debt maturities, working capital needs, and projected dividend distribution to shareholders.
The stable outlook reflects the stable outlook on the rating of Sinopec’s parent. We expect Sinopec to weather through the current operating conditions and maintain its “intermediate” financial risk profile despite losses from the chemical and refining segments for the first nine months of 2012. The outlook also factors in our view of an “extremely high” likelihood of extraordinary government support in the event of financial distress.
We may upgrade Sinopec if we raise the sovereign credit rating on China. We could also raise the rating if the stand-alone credit profiles of Sinopec and Sinopec Group improve. This could happen if: (1) the Chinese government liberalizes its pricing mechanism for refined products, such that Sinopec earns reasonable returns on its refining business; or (2) the current regulatory environment prevails, but Sinopec overcomes the challenges and improves its financial risk profile, such that Sinopec and its parent’s ratios of adjusted debt to EBITDA are less than 2x and the ratios of FFO to total adjusted debt are more than 45% on a sustainable basis.
Although unlikely, we may lower the rating on Sinopec if government support to the company declines because of a change in the government’s strategies or priorities. We may also lower the rating if the company’s stand-alone credit profile deteriorates to speculative grade, although the probability of this happening appears remote.