OREANDA-NEWS.  Fitch Ratings has affirmed city piped gas distributor China Resources Gas Group Limited's (CRG) Long-Term Issuer Default Rating (IDR) at 'BBB+' with a Stable Outlook. CRG's senior unsecured rating is also affirmed at 'BBB+'.

CRG's IDR incorporates a one-notch uplift for potential support from its immediate parent, China Resources Holdings Limited (CRH), which owns 64% of CRG. CRH is wholly owned by the State Assets Supervision and Administration Commission (SASAC) of China (A+/Stable). CRG's stand-alone 'BBB' rating reflects its diversified operations, its strong credit metrics and liquidity, robust industry fundamentals as well as risks associated with the city gas industry in China.

KEY RATING DRIVERS

Strong Operating and Financial Performance: CRG's operating performance continues to be strong, supported by increasing gas sales and new connections. In 2014, its revenue rose 28.8% to HKD28.7bn and EBITDA increased 34% to HKD5.1bn. City gas concessions increased to 205 at end-2014 from 176 a year earlier with connected residential users up 12.7% to 20.7m and commercial & industrial (C&I) users up 11.1% to142,172. Fitch expects CRG's business will continue to be supported by the nation's increased usage of natural gas, although we expect a lower growth of around low double digits given the general economic slowdown in China.

Increasing Contribution of Gas Sales: Fitch estimates EBITDA from sale and distribution of gas fuel and related products rose to about HKD3.4bn in 2014 from HKD2.7bn in 2013. Although the larger contribution of lower-margin recurring gas sales may have reduced the overall profit margin of the company, Fitch considers the higher contribution of EBITDA from gas sales to be positive for the company because gas sales are more stable than gas connection fees. This is a trend we have observed across the leading operators as the industry matures.

Dollar Margin Maintained: CRG's dollar margin on gas volume sold has been stable through the price adjustments, despite some delays in certain areas. China's National Development and Reform Commission (NDRC) in the past year announced two price adjustments in September 2014 and April 2015. The price adjustments are broadly in line with NDRC's announced mechanism to price natural gas sold to city gas operators based on the price of a basket of energy products, mainly crude oil and liquefied petroleum gas (LPG). Fitch expects the stability of crude oil prices at lower levels to reduce the cost pass-through risks and delays for city gas operators, provided the current pricing mechanism remains unchanged.

High Capex, Cash Hoarding: CRG's management expects capex, capital injections into project companies (partly to increase ownership) and acquisitions to remain at elevated, compared with 2013 and 2014 levels, which would require the company to maintain a large cash reserve. Management says the inorganic growth will taper off after 2018, after which it will continue to increase stakes in its JVs and associate project companies. In Fitch's view, funds flow from operations (FFO)-adjusted gross leverage would be an important measure of CRG's leverage because a meaningful portion of the large cash reserve is being used for the above purposes. Fitch expects CRG's FFO adjusted leverage to remain above 3x (2014: 3.9x).

Robust Credit Metrics: Fitch expects CRG to have positive free cash flows before acquisition spending, supported by strong gas sales and connection revenue growth. Barring any material increase in investments or cash returns to shareholders, CRG could further improve its already robust credit metrics. Fitch expects FFO to net adjusted debt to remain comfortably below 2x (2014: 1.5x), and FFO fixed charge coverage to remain above 6x (2014: 6.6x).

KEY ASSUMPTIONS

Fitch's key assumptions within our rating case for the issuer include:
- Gas sales volume growth remains in the low double digits
- Turnover from connection fees remains stable
- Dollar margin remain stable, that is, increase or decrease in gas procurement costs are passed through to end-users
- Capex, capital injections into project companies and acquisitions remains higher than levels in 2013 and 2014, which imply the cash balance and total debt will remain high

RATING SENSITIVITIES
Positive: Future developments that may, individually or collectively, lead to positive rating action include:
- FFO adjusted gross leverage lower than 3x and FFO fixed charge coverage higher than 6x, on a sustained basis
- FCF after capex, acquisitions and dividends at least reaching broadly break-even on a sustained basis
- clearer regulatory regime, continued demonstration of the company's ability to pass through costs increases without materially affecting margins, and the overall business risk profile not weakening due to investments outside of the city gas distribution business

Negative: Future developments that may, individually or collectively, lead to negative rating action include:
- FFO adjusted net leverage higher than 4x on a sustained basis
- FFO fixed charge coverage lower than 4x on a sustained basis
- Expansion into non-city gas businesses that will materially change the company's business risk profile
- a material deterioration in the regulatory environment or worse-than-expected weakening of profitability of the city-gas distribution operations, which may arise from not being able to translate higher gas procurement costs into higher tariffs
- weakening of the effective linkages with its parent, China Resources Holdings Limited, and SASAC