Fitch Places Chongqing Energy's 'BBB' Ratings on Rating Watch Negative
(The following statement was released by the rating agency)Fitch Ratings-Hong Kong-05 February 2021:
Fitch Ratings has placed Chongqing Energy Investment Group Co., Ltd.'s (Chongqing Energy) Long-Term Foreign-Currency Issuer Default Rating (IDR) and senior unsecured rating of 'BBB' on Rating Watch Negative (RWN). The agency also placed the 'BBB' rating on Chongqing Energy's USD500 million 5.625% senior unsecured notes due 2022 on RWN.
The rating actions follow Chongqing Energy's recent decision to close all 14 of its Chongqing-based coal mines by July 2021 under China's supply-side reforms. These mines have a total annual capacity of 11.5 million tonnes.
The Rating Watch Negative reflects the possibility of a reassessment of Chongqing Energy's likelihood of support from its owner Chongqing municipal government under our Government-Related Entities Rating Criteria, in particular the attributes of support track record and socio-political implications of default.
The assessment is pending clarity on the Chongqing government's plan to provide financial support to assist the company in maintaining adequate liquidity and a sustainable financial profile after the mine closures, as well as the company's future role in ensuring coal supply for Chongqing. We note that a significant share of Chongqing Energy's debt relates to the mines that will be closed, although the coal mining operations were not very profitable.
The company indicated to Fitch that the Chongqing municipal government will continue to provide strong support, including helping the company manage its near-term liquidity needs, aid its business transition plan, and strengthen its financial profile.
The company expects to remain the core energy supply and investment platform in Chongqing and expand its coal procurement capacity and make strategic coal investments outside Chongqing. However, detailed supportive policies and action plans have not been announced, and may take time to materialise as it would require government coordination with various constituencies. The company's socially important city-gas and power generation operations will be maintained.
Chongqing Energy's Standalone Credit Profile (SCP) of 'b-' is also placed on negative watch, pending clarity on the company's business transition and financial improvement plan.
Chongqing Energy's IDR of 'BBB' is credit-linked with Fitch's internal credit assessment of Chongqing Municipality, based on a score of 22.5 points under Fitch's Government-Related Entities Rating Criteria, reflecting 'Strong' assessment of status, ownership, and control, 'Moderate' support track record, 'Strong' socio-political implications of default, and 'Moderate' financial implications of default. A lowering of this score could lead to a change in the rating approach from top-down to bottom-up, which may lead to a multi-notch downgrade of the IDR.
Key Rating Drivers
Coal Mine Shut-down: The company announced it will shut down all its Chongqing-based coal mines before July 2021, as part of efforts to eliminate inefficient, accident-prone mines. Chongqing Energy closed 31 coal mines in 2015-2020. The 14 mines that are due to be shut accounted for around 85% and 11% of Chongqing Energy's total coal production capacity and total assets at end-2020, respectively.
The workers' settlement will be completed soon, funded through internal resources, government subsidies, and other types of financing that the government is coordinating.
Government Support to be Tested: Fitch's assessment of the support track record for Chongqing Energy will depend on the financial support that Chongqing government will provide to the company to help it maintain an adequate financial profile after the mine closures. The 14 coal mines generate limited operating cash flows due to their high cost positions. However, the majority of the company's CNY47 billion of interest-bearing debt at end-2020 was bank debt and finance leases related to its coal mining operations, including costs incurred during shut-downs in 2015-2020.
Chongqing Energy expects to resolve the legacy debt burden with its lenders, most of which are state-owned banks, with help from the government.
Socio-Political Implications of Default Uncertain: Chongqing Energy's mines accounted for around 72% of Chongqing's local coal production capacity and satisfied around 35% of the municipality's coal consumption in 2020. With the closure of its locally based coal mine productions, the extent of the company's future involvement in securing essential energy supply for the city is uncertain as there is no clarity now on how the company will execute its new coal strategy.
The current 'strong' assessment of 'socio-political implications of default' reflects its critical role as Chongqing's major energy supplier of a combination of coal, power and gas. The company dominates the city-gas market, servicing 25 districts and counties and nearly 60% of the city's end-users, and operates more than 80% of the municipality's gas pipeline network. The output from its consolidated power plants meets around 10% of the municipality's power consumption. These operations will be maintained with no changes.
Chongqing Energy's support record is currently assessed as 'Moderate', which is in line with that for Yunnan Provincial Energy Investment Group Co., Ltd. (YEIG, BBB/Stable), as both companies receive ongoing government subsidies and grants. The level of support has been weaker than for Zhejiang Provincial Energy Group Company Ltd. (ZEG, A/Stable), whose support record attribute is assessed at 'Strong'. Chongqing Energy's financial profile could deteriorate after the coal mine closures if government support is not sufficient to enable the company to maintain an adequate financial profile. If that were to happen, this assessment could be revised to 'Weak'.
Chongqing Energy's socio-political implications of a default is currently assessed as 'Strong' given its strategic mandate as the exclusive energy supplier controlled by the municipal government and its critical role in protecting local energy security. The assessment could be 'Moderate' if the company's role as the municipality's coal supplier weakens.
In comparison, we assess this attribute as 'Moderate' for YEIG to reflect its lower contribution to provincial energy supply through mostly minority investments in power generation assets, which makes a severe energy-supply disruption improbable in the event of a YEIG default.
We assess Chongqing Energy's status, ownership and control as 'Strong', reflecting broad control by the Chongqing municipal government. We assess this attribute as 'Very Strong' for Beijing Energy Holding Co., Ltd. (A+/Stable) and ZEG, as the level of government involvement in the entities' operation, funding and investments is exceptionally high.
Our assessment of the financial implications of a default by Chongqing Energy is 'Moderate', compared with 'Strong' for YEIG and 'Very Strong' for ZEG. Both YEIG and ZEG are leading state-owned entities that enjoy lower funding costs than most state-owned entities in their respective provinces. We observe that YEIG and ZEG are viewed by creditors as borrowers that are closer to the government than Chongqing Energy.
Factors that could, individually or collectively, lead to positive rating action/upgrade:
- As the rating is on RWN, a positive rating action is unlikely in the short term. We will resolve the RWN based on the developments and actions plans put forward by the company.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
- Insufficient and timely support from the Chongqing government, including the inability to present a plan that allows the company to manage the transition and the debt associated with the coal-mining operations
- Inability of the Chongqing government to present a clear strategy and action plan to maintain Chongqing Energy's position as a coal supplier to the region in the absence of its own coal mines, which would sustain the current assessment of socio-political impact of default under Fitch's Government-Related Entities Rating Criteria.
Best/Worst Case Rating Scenario
International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.
Liquidity and Debt Structure
Weak Liquidity, Modest Public Bonds: The company reported cash of CNY10.5 billion as of end-9M20, of which a large portion is restricted. This amount is not sufficient to meet its short-term debt of around CNY16 billion. The company expects the Chongqing government to provide support and coordinate with its bank lenders to maintain its liquidity position.
The company's capital market debt is modest compared to its bank debt. At end-9M20, the company had around CNY5 billion of bonds outstanding. The only public issuance is the USD500 million 5.625% senior unsecured notes due 18 March 2022, while the remaining bonds are onshore private placements with a small amount due before the offshore bond.
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING The principal sources of information used in the analysis are described in the Applicable Criteria.
Public Ratings with Credit Linkage to other ratings
The ratings on Chongqing Energy are linked, but not equalised to Fitch's internal assessment of the creditworthiness of Chongqing municipality, based on Fitch's Government-Related Entities Rating Criteria.
Chongqing Energy Investment Group Co., Ltd.; Long Term Issuer Default Rating; Rating Watch On; BBB; Rating Watch Negative
----senior unsecured; Long Term Rating; Rating Watch On; BBB; Rating Watch Negative
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