Shandong Energy And Its Guaranteed Notes Assigned #BB# And #cnBBB-# Outlook Stable

Stocks and Financial Services Press Releases Thursday July 13, 2017 09:33
HONG KONG--13 Jul--S&P Global Ratings
HONG KONG (S&P Global Ratings) July 13, 2017-- S&P Global Ratings today said it assigned its 'BB' long-term corporate credit rating to Shandong Energy Group Co. Ltd. The outlook is stable.

We also assigned our 'BB' long-term issue rating to the company's proposed guaranteed senior unsecured notes. At the same time, we assigned our 'cnBBB-' long-term Greater China regional scale rating to the company and the notes.

Shandong Energy is the largest coal miner in China's Shandong province, and has other businesses including trading, machinery manufacturing, chemicals production, and power generation.
Our ratings on the notes are subject to our review of the final issuance documentation.

The ratings reflect Shandong Energy's 'b' stand-alone credit profile (SACP) and our view of a high likelihood that the government of Shandong province would extend timely and sufficient extraordinary support to the company in case of financial distress. We view Shandong Energy as a government-related entity (GRE).

Our assessment of the likelihood of extraordinary government support is based on following characteristics: A very strong link with the Shandong provincial government.

Shandong provincial government wholly owns Shandong Energy via Shandong State-owned Asset Supervision and Administration Commission (SASAC, shareholding 70%) and the Shandong Province Council for Social Security Fund (30% shareholding). Shandong SASAC appoints the company's board members and senior management.

In our view, the local government has a strong influence on the company's strategy and business plans and has procedures in place to continuously monitor the company.

Additionally, Shandong Energy transformed into a state-owned capital investment company in 2015, partly shouldering the responsibility of Shandong SASAC, including the supervision of state-owned assets and the conservation or increase in the value of state-owned assets.

We believe that a considerable deterioration in the creditworthiness of Shandong Energy Group would significantly affect the Shandong government's reputation. It would also negatively affect other GREs controlled by the local government to access the debt capital market.

An important role to the Shandong provincial government. Shandong Energy operates as a profit-seeking entity in the competitive coal industry. It is the third-largest coal producer in China in 2016 and the largest one in Shandong.

As one of the first coal companies that expanded outside of China, it plays an important role in helping the government to secure more coal resources worldwide. Moreover, Shandong Energy is one of the coal companies identified by the Shandong government to be a consolidator of the fragmented coal industry.

The Shandong government controls around 20 major state-owned enterprises (SOEs). In 2016, Shandong Energy was the largest SOE in Shandong by revenue, the second-largest by asset size, and the third-largest by profit. As such, we view Shandong Energy's credit standing to be important for the Shandong government. We believe a credit stress or default by the company would have an important impact on the coal sector.

Shandong is a coastal province, with above-average GDP per capita at US$10,000 in 2015-2016. We expect the economy will expand by 7.0%-7.5% over the next two to three years, faster than international peers and China's national average growth.

This growth rate will contribute to robust revenue growth; the provincial government's operating revenues increased by an average rate of 6.5% over 2014-2016. We view the intergovernmental regime between Shandong and the central government as evolving and unbalanced.

This system heavily influences Shandong's financial management, with the central government appointing experienced members to senior leadership positions. Overall, Shandong continues to navigate a fine line between maintaining strong economic growth and adhering to the central government's tightening stance on borrowings by local and regional governments.

Although Shandong's fiscal system is largely predictable, it is characterized by revenue and expenditure imbalances, and weak transparency and accountability. Shandong's key credit weaknesses include its very high debt burden and very high contingent liabilities. However, the province has strong budgetary flexibility, and exceptional liquidity, which supports Shandong's individual credit profile.

The SACP of Shandong Energy mainly reflects our view of the company's coal mining business. We expect this business to contribute to 70%-80% of the company's profit in the next two to three years.
Shandong Energy has rich coal reserves, long mine life, large operational scale, and a mid-level cost position. We see good growth potential for the company in the next two to three years.

These strengths are partly offset by Shandong Energy's dependence on a single commodity, limited geographical and product diversity, high debt leverage, and negative free cash flows. We expect the company to further enlarge its operational scale and to speed up the development of its overseas projects in the next two to three years. Shandong Energy plans to add 40.0 million tons of new capacity by 2019, while closing 22.0 million tons of mostly idled capacity in the 13th five-year period that ends in 2020.

The company also plans to start the construction of its 2.0 million-ton coking coal mining project in Australia in 2017 and targets to finish construction by end-2019.

We expect the cost of the new mines to be in line with, or lower than, that of existing mines and to increase the proportion of higher-priced coking coal in the sales mix. We believe the coal industry will experience more balanced supply and demand in the next one to two years, benefiting from industry de-capacity in China.

We therefore expect coal prices will remain stable during the period, despite potential weakness in the short-term with increasing supply.
We forecast Shandong Energy's leverage ratios will gradually improve in the next two to three years due to stable coal prices and increasing sales volume.

Nonetheless, we expect the company's leverage will remain high during the period to support its coal capacity addition and expansion in the chemicals and power businesses. We also expect the company to continue to have high working capital outflows mainly due to increasing accounts receivables.

We estimate Shandong Energy's debt-to-EBITDA ratio to be at 5.7x-6.5x in 2017-2019 and its ratio of discretionary cash flow to debt to remain negative during the period. We equalize our ratings on the proposed guaranteed senior unsecured notes to the ratings on Shandong Energy, even though the company's priority debt to total assets ratio exceeds our notching down threshold of 20%.

Shandong Energy owns multiple operating entities to manage different mines, and it allocates the proceeds from notes issuances to its operating subsidiaries. These, in our view, should help to reduce the structural-subordination risk associated with debt at the parent company level.

The issuer Shandong Energy Australia Pty Ltd. is wholly owned by Shandong Energy Group. It intends to use the issuance proceeds for debt repayment and for other general corporate use. Shandong Energy Group provides an unconditional and irrevocable guarantee to the notes.

The stable outlook on Shandong Energy reflects our view that the Chinese coal industry will experience a more balanced supply and demand in the next one to two years, benefiting from industry de-capacity. We therefore forecast that Chinese and international coal prices will remain stable during the period.

We expect Shandong Energy's financial position to improve over the next 12-24 months owing to stable coal prices and increasing sales volume but still remain highly leveraged because of the company's hefty debt and high capital spending.

We could lower the ratings on Shandong Energy if the company's financial leverage deteriorates in the next two to three years.

This may happen if coal prices are 15%-20% below our expectation. We could also lower the ratings on Shandong Energy if the likelihood of extraordinary government support weakens, which we view as unlikely in the near term.

We may upgrade Shandong Energy if its financial leverage materially improves for a sustained period. An indication of such improvement is that the company's debt-to-EBITDA ratio falls below 5.0x, which could happen due to higher-than-expected coal price or lower-than-anticipated capex.


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