May 16, 2014 / 7:13 AM / 4 years ago

Investors gain with reform of China's state-owned companies

* Companies sell assets with low returns

* Additional cash improves ability to pay debt

* Shift to higher return projects benefits stockholders

By Lianting Tu

HONG KONG, May 16 (IFR) - Credit and equity investors in China’s energy sector are already benefiting from wide-ranging reforms of the country’s state-owned enterprises.

Petrochemical and energy companies, including some of the biggest capital-market issuers, are beginning to offload non-core assets under a state-backed plan to improve efficiency in the public sector.

The disposals of low-return assets will add cash to balance sheets of companies and, ultimately lead to lower gearing and better debt-servicing ability. This may mean less pressure for such companies to issue new debt or equity - good news for investors, said Anthony Leung, credit desk analyst at Nomura.

China National Petroleum Corp announced plans on Monday to sell parts of two major pipelines in China. This follows a similar move from peer China Petroleum & Chemical Corp, or Sinopec, which announced in February the sale of up to 30% of its gas-station business to private investors.

Other energy companies, such as China National Offshore Oil Corp and State Grid Corporation of China have also set up special committees to focus on reforms, according to Standard & Poor’s analyst Lawrence Lu, who covers state-owned entities for S&P.

The Third Plenum of the Chinese Communist Party in November 2013 made it a priority to invite private capital, as well as improve governance and working efficiency, to promote mixed ownership for state-owned companies.

“The reform is good for everyone. It’s good for the shareholders and bondholders, and the economy,” said Nomura’s Leung.


China’s state-owned companies lag their private sector counterparts on many financial measures, and, generally, have weaker balance sheets and lower productivity.

On average, China’s over 17,000 state-owned companies were carrying debt equal to 4.6 times their earnings at the end of 2012, compared with just 2.8 times for private companies, according to a research report from Yukon Huang, senior associate specialising in the Chinese economy at Carnegie, a research centre.

About two thirds of bank lending goes to state-owned companies, but they contribute only one third of national output, according to Huang.

Standard Chartered analysts calculated a return on assets for state-owned companies of around 5% at end-2012 - half that for the private sector.

Financial reforms and tighter credit controls in China’s banks are also accelerating the drive to invite more private capital into the public sector.

“Banks are increasingly careful about lending to lost causes, and the idea that (state-owned companies) will always repay loans now has less credence,” the Standard Chartered analysts wrote.


The energy sector, with a strong track record among private investors, is a natural starting point for the reform of state-owned companies, but analysts expect the trend to catch on quickly once the first precedents are set.

“It is easier for energy companies to sell assets as they already have a large following and, as they are gigantic in size, they are more effective in setting examples for the others to follow,” said a Hong Kong-based credit analyst.

While any move towards privatisation threatens to remove the government safety net for investors, a more efficient public sector will be advantageous for individual investors and the wider economy. Indeed, the disposals are aimed at reaching clear profitability targets.

“The government is encouraging oil companies to divest stakes in assets with internal rate of return of less than 12% and reinvest the proceeds in higher-return projects, such as upstream exploration and production with IRR of above 18%,” said Nomura analysts in a research note.

CNPC’s plan to divest its low-return gas pipelines is likely to improve its credit profile. The move will not only reduce debt, it will also recycle capital to support more profitable and strategically important projects, such as the development of domestic natural gas fields and the acquisition of overseas oil-and-gas reserves, Moody’s said in a ratings report.

Investors are already starting to benefit. The Hong Kong-listed shares of Sinopec are up 12.6% this year, while those of PetroChina, CNPC’s listed unit, rose 2.8% on Tuesday after it announced the pipeline sale.

Credit-market participants believe CNPC’s bonds will have support from a decline in supply. Analysts expect the company to use the proceeds from the sale of the pipelines - valued at US$4.7bn-US$6.3bn - to cover some of its capital expenditure needs for this year and, consequently, reduce demand for new debt.

Some analysts also believed CNPC’s decision to issue only US$1.5bn of offshore bonds earlier this month, far short of market expectations of around US$3bn, was partly due to the upcoming asset sale. (Reporting By Lianting Tu; editing by Christopher Langner and Steve Garton)

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