State Grid Corp. Of China #AA-# Rating New MTN Program Rated #AA-#

Stocks and Financial Services Press Releases Tuesday April 18, 2017 17:35
HONG KONG--18 Apr--S&P Global Ratings

HONG KONG (S&P Global Ratings) April 18, 2017--S&P Global Ratings today affirmed its 'AA-' long-term corporate credit rating on State Grid Corp. of China (SGCC). The outlook is negative. We also affirmed our 'cnAAA' long-term Greater China regional scale rating on the largest power transmission and distribution company in China. In addition, we affirmed our 'AA-' long-term issue rating and 'cnAAA' Greater China regional scale rating on the outstanding notes that SGCC guarantees.

At the same time, we assigned our 'AA-' long-term issue rating and 'cnAAA' Greater China regional scale rating to the US$7.7 billion medium-term note (MTN) program and the first issuance, for which SGCC will provide unconditional and irrevocable guarantees.

The issuer is State Grid Overseas Investment (2016) Ltd., a British Virgin Islands incorporated entity established for the purpose of debt issuance, and indirectly wholly owned by SGCC. The issue ratings are subject to our review of the final documentation.

We affirmed the ratings because we expect SGCC will maintain robust cash flows over the next two to three years amid a pickup of power demand in China and stable tariffs. We also expect the company to continue benefiting from an extremely high likelihood of extraordinary support from the Chinese central government if needed.

"In our view, ongoing power sector reforms in China will not disrupt the flow of stable tariffs to SGCC or have material influence on the grid operators," said S&P Global Ratings credit analyst Gloria Lu.
China is rapidly rolling out its new transmission and distribution (T&D) regulatory framework to all 26 provincial networks of SGCC by the end of 2017.
Under the framework, T&D tariffs will be assessed on an "approved costs plus reasonable return" basis, which may enable the operators to fully recover their operating costs, investments, and capital costs.

"We believe tariffs for those provincial networks approved so far are set on par with the historical levels to smooth out large swings during the transition period to the new framework, and to preserve the financial stability of the grid operators," Ms. Lu said.

For example, the equity return under the new framework is made by reference to China's long-term treasury bill rate plus a risk premium in a range of 1%-4%. This sliding-scale risk premium approach is designed to account for the different historical returns of provincial networks due to differences in economic development, market structure, and affordability.

In our opinion, the new tariff-setting mechanism could be positive to grid operators in the longer term by enhancing the stability and visibility of returns and cash flows. That said, the regulatory regime is evolving, so our expectations will not be immediately reflected in the business profile assessment and the ratings on SGCC.

SGCC's appetite for overseas expansion is above-average compared with other Chinese companies. SGCC expects that its offshore businesses will contribute about 10% of the group profit by 2020 compared with 6%-7% as of 2016. SGCC executes its strategy through its sole overseas investment platform, State Grid International Development Ltd. (A+/Negative/--; cnAAA/--/--). We expect appropriate equity and debt funding for transactions consistent with what we

have seen in the past.

We also expect the political, regulatory, cultural, and foreign exchange risks associated with overseas investments are moderated by SGCC's geographic diversity, and the stable nature of the regulated overseas assets that SGCC

has acquired or targets.

We believe SGCC continues to perform a critical role to the government and the national energy strategy through ensuring safe and reliable power supply in China. The company supports the government's renewable energy initiatives and provides electricity to less-developed regions. SGCC also has a very strong link to the government through its 100% state ownership and the government control over the company through the board and the appointment of senior


We equalized the issue ratings on the MTN program and its first issuance with the corporate credit rating on SGCC because we believe SGCC's guarantee is unconditional and irrevocable and therefore the issue qualifies for rating substitution treatment. The equalization also reflects our view that SGCC's geographical diversification could reduce structural subordination risk associated with the guarantee obligation of SGCC at the holding company level.

The negative outlook on SGCC reflects our negative outlook on the sovereign rating on China. Both ratings will move in tandem because of our assessment of an extremely high likelihood of support from the Chinese central government to the company.

"We expect SGCC, on a stand-alone basis, to maintain its current credit profile over the next 24 months owing to its ability to preserve margins through stable T&D tariffs and the moderate growth of power demand in China. Meanwhile, we believe the power sector reform in China, albeit still evolving, is likely to have a long-term positive credit implication on SGCC," Ms. Lu said.

We will lower the rating if the sovereign rating on China is lowered, or in a very remote scenario, we assess that the likelihood of extraordinary government support to SGCC is reduced.

We could also lower the rating if the company's stand-alone credit profile deteriorates by two notches or more. This could happen if: (1) SGCC pursues sizable debt-funded capital spending or acquisitions that are substantially more aggressive than our base case; or (2) the regulated T&D tariffs are much lower than historical levels and materially weaken SGCC's margins and cash flows. An FFO-to-debt ratio approaching 25% on a consistent basis could put downward pressure on the rating.

We will revise the rating outlook on SGCC to stable if the sovereign rating outlook on China is revised to stable.

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