Fitch Affirms China Three Gorges at 'A '; Outlook Stable
Simultaneously, Fitch has affirmed the ratings of Three Gorges Finance I (Cayman Islands) Limited's USD700m 3.7% senior unsecured notes due 2025 and Three Gorges Finance II (Cayman Islands) Limited's EUR700m 1.7% senior unsecured notes due 2022 at 'A+'.
CTG's ratings are equalised with the China sovereign (A+/Stable), its sole owner, as per Fitch's Parent-Subsidiary Linkage methodology. The equalisation reflects CTG's critical role in China in terms of flood control, drought relief, navigation improvement and water supply, as well as the strength of policy and financial support CTG consistently receives from the state.
KEY RATING DRIVERS
Critical Role in China: CTG is responsible for six large hydropower stations (four operational and two under development) on the Yangtze River, one of China's two main rivers. The hydropower stations, including the high profile Three Gorges Project, serve around half of China's provinces - including some of the highly populated and economically important regions - in terms of flood control, drought relief, navigation improvement and water supply. CTG is supervised by the State Council, the country's highest policy-making body, and the National People's Congress, the national legislature of China, reflecting its significance to the state.
Leader in Hydropower: CTG is the nation's largest hydropower producer, accounting for around 16% of the country's hydropower capacity at end-2015 and supplying 12 of China's 32 provinces and municipalities. The electricity generated from Three Gorges has a regulated on-grid tariff of 26 cents per kilowatt hour (kwh), 30%-40% lower than the average thermal power on-grid tariff in the regions the Three Gorges Project serves, which supports the regional economy development with clean and affordable energy.
Unparalleled Level of Government Support: The government has offered CTG material tangible support, including equity injections, consistent subsidies and tax rebates. The central government until 2009 ran The Three Gorges Project Construction Fund (TGP Fund), which collected a portion of retail power tariff nationwide and injected the majority of this collection into CTG as equity for the construction of the Three Gorges Project. In recent years, CTG has received around CNY4bn of operational subsidies per year and substantial financing support for its overseas investments through state-owned policy banks.
Accelerated Global Expansion: CTG has won 30-year concessions for two hydropower plants in Brazil around end-2015 - Jupia and Ilha Solteira power stations that are currently operated by Brazil's Companhia Energetica de Sao Paulo with a combined capacity of 4.99 gigawatts (GW). The acquisition will help CTG to diversify operations, which are concentrated on the mid- to up-stream of Yangtze River. The acquisition cost of around BRL13.8bn will increase CTG's financial leverage moderately, but its balance sheet quality still remains very strong. Fitch expects CTG's FFO adjusted net leverage to be under 4x by end-2015.
'BBB' Standalone Credit Profile: CTG's robust cash generation from its 45.5 gigawatt hydropower capacity at its four plants on Yangtze River supports its investment-grade standalone profile. China's policies to encourage clean energy development - such as giving electricity from clean energy sources priority access to the grid (dispatch priority) and regulated tariffs - along with the scale and diversity of CTG's downstream customers ensure that its electricity sales have minimal price and volume risk. Fitch expects these policies to continue with China's ongoing energy reform to prioritise clean energy development. Fitch estimates that CTG could maintain a FFO fixed-charge coverage above 4x (end-2014: 5.6x), and FFO-adjusted net leverage under 5x in the next two to three (end-2014: 3.3x), supported by a robust EBITDA margin of around 70%. This financial profile together with the operating risk profile of the company, places its standalone credit profile in the mid-'BBB' category.
Fitch's key assumptions within the rating case for CTG include:
- Average utilisation hours of the hydropower plants to remain stable around the historical average
- Hydropower on-grid tariff to remain flat at the current level
- Annual expenditure around CNY50bn for the next three to four years
- Higher dividend receipts from its 62%-owned subsidiary China Yangtze Power Company Limited (CYPC, A+/Stable), following the sale of the two hydropower generation assets to CYPC by CTG; CYPC has guided CNY14bn annual dividend from 2016 to 2020
Positive rating action may arise from positive rating action on China sovereign, provided linkages between CTG and the sovereign remain intact.
Negative rating action may arise from negative rating action on China sovereign or weakening of the linkages between CTG and the sovereign, such as a material decrease of state control or government support.
For the sovereign rating of China, the following sensitivities were outlined by Fitch in its Rating Action Commentary of 26 November 2015:
The main factors that individually, or collectively, could trigger positive rating action on China include:
- Increased evidence that the economy can adjust smoothly while rebalancing without experiencing a disruptive "hard landing"
- Greater confidence that the debt problem in the broader economy can be resolved without a material negative impact on growth or financial stability
- Widespread adoption of the renminbi as a reserve currency globally
The main factors that individually, or collectively, could trigger negative rating action on China include:
- A sharper growth slowdown than currently anticipated, leading to a materialisation of risks to financial and/or social stability
- A rise in estimated general government indebtedness well above Fitch's current estimate
- Sustained capital outflows sufficient to erode China's external balance-sheet strengths, or undermine financial stability
- A change in policy direction that signalled decreased willingness to tackle the economy's imbalances and vulnerabilities, thereby increasing the risk of an eventual disorderly adjustment