Fitch: China Coal Company's CNY Bond Default Underlines Sector Risks
OREANDA-NEWS. Fitch Ratings says today that a default on bond payments by ChinaCoal Group Shanxi Huayu Energy Co Ltd (Shanxi Huayu) highlights the very difficult situation that many Chinese coal mining companies face.
The lower prices, reduced demand and industry over-capacity have significantly affected profitability and cash flow health of not only smaller-scale companies like Shanxi Huayu, but also major coal enterprises such as Yanzhou Coal Mining Company Limited (Yancoal, B/Negative) and China Shenhua Energy Company Limited (Shenhua, A+/Stable).
Shanxi Huayu, which is 49% ultimately owned by the state-owned China National Coal Group Corp, failed to pay CNY637.7m in principal and interest on its domestic short-term commercial paper that matured on 6 April 2016. This is the first domestic bond default by a company controlled by a state-owned coal mining group since 2012, when coal prices tumbled and dragged many coal companies into financial stress. Twenty of China's 33 listed coal companies reported net losses in 2015, while another eight posted net profit declines of 57% to 93% from a year ago (see Fitch Special Report "China Coal Sector's Financial Woes to Worsen in 2016" dated 18 February 2016).
The reliance on short-term funding by Chinese corporates, including state-owned companies, has increased. This is partly driven by lower interest costs of such short-term debt instruments. At the same time, many state-owned companies have increasingly tapped short-term debt funding due to regulatory ceilings on long-term debt. An increased reliance on short-term paper leads to higher liquidity risks for companies, especially those with weak operating and financial fundamentals. In addition, a clear trend on how the state would support state-owned companies in competitive industries with severe over-capacity is yet to emerge.
Shanxi Huayu is a medium-sized coal-mining company in China, with total assets of CNY23.bn at end-September 2015, compared to Yancoal's CNY142.5bn at end-2015 and Shenhua's CNY559.8bn at end-2015. Typically, smaller scale companies are financially less flexible and are harder hit by price volatilities. Shanxi Huayu's high operating expenses have historically rendered it much less profitable than Yancoal or Shenhua. Shanxi Huayu has reported net losses since 2014, while Yancoal and Shenhua reported net profits in 2014 and 2015. Shanxi Huayu generated negative operating cash flow in 2013 and 2014, and was only marginally operating cash flow breakeven for the first nine months of 2015, based on Fitch's estimates.
Chinese coal companies will continue to face difficulty in preserving their credit strength amid low prices and hefty industry over-capacity. On 11 April 2016, Fitch downgraded Yancoal's Long-Term Issuer Default Rating to 'B' with a Negative Outlook. Despite its strong market position and aggressive cost cutting, Yancoal has not been able to improve its balance sheet due to its substantial capital expenditures. Its FFO adjusted net leverage was 10x at end-2015.
Fitch expects Yancoal's elevated capex to constrain free cash flow generation and hence any improvement in financial position over the next two years. The company's capital structure has weakened with a substantial rise in short-term debt in 2015, which increases the company's liquidity risks despite its good access to domestic funding sources given its state-owned enterprise status.
Shenhua, a top-tier coal mining company globally, continues to benefit from its vertically integrated business model. Cash flow from its more stable power generation business, which accounted for 43% of EBITDA in 2015, has partly offset the substantial decline in coal mining cash flow. However, the company's FFO net leverage still rose substantially to 1.3x at end-2015 from 0.9x a year ago, primarily due to the decline in coal prices and sales volume.
Shenhua has announced a substantial 44% cut in capex for 2016 which could help strengthen its free cash flow and prevent another spike in leverage. Nonetheless, coal prices and demand are likely to remain subdued in the near term. The power generation business, which benefited from lower fuel prices in 2015, had a 7% cut in on-grid tariff from 1 January 2016, and will face increasing challenges from over-capacity.
Fitch believes a substantial rebound in coal prices is unlikely in short-term. Concerns from regional governments, including about employment and local GDP growth, are likely to slow down the process of capacity cuts, even though the central government has directed the closure of older and high-cost mines,. In addition, coal consumption will remain subdued with the rebalancing of China's economy structure. Therefore, credit profiles of many Chinese coal mining companies will continue to face severe pressure.