China Resources Gas Group Ltd. Upgraded To #A-# On Strong Financial P Outlook Stable

Stocks and Financial Services Press Releases Friday June 15, 2018 17:46
--15 Jun--S&P Global Ratings

HONG KONG (S&P Global Ratings) June 15, 2018--S&P Global Ratings raised its long-term issuer credit rating on China Resources Gas Group Ltd. (CR Gas) to 'A-' from 'BBB+'. The outlook is stable. CR Gas is a large city-gas investor and operator with a national footprint.

We raised the rating because we expect CR Gas to continue to have a strong operating performance and improve its financial performance over the next 12-24 months. The company's rapid growth in gas sales volume, stable margin, and disciplined capital spending will support the improvement.

We expect CR Gas to maintain financial discipline while pursuing growth such that the ratio of funds from operations (FFO) to debt remains at 60%-70% in 2018-2020. The ratio was 61% in 2017, supported by a robust 11% growth in EBITDA and repayment of Hong Kong dollar (HK$) 1 billion in debt. We believe the company's operating cash flow can satisfy its capital spending requirements, and its free operating cash flow would remain positive over 2018-2020.

We believe that CR Gas will continue to operate under an evolving regulatory regime but with better transparency in the next two to three years. Following the central government's "Opinion on regulating city gas distribution sector" in June 2017, local governments have gradually formulated provincial guidance in the first half of 2018. Under the new regime, the permitted return on gas sales is set at a maximum of 7% of approved assets. The new regulations do not include connection fees. Currently, connection fees make up at least a third of the cash flows and profit of city gas companies.

A gas shortage in China is likely to reduce in 2018 compared with 2017, helping CR Gas to stabilize its margin. The government has prioritized resolving the natural gas shortage in the heating season by encouraging companies to scale up investments in gas storage and to diversify sources of gas imports. Due to gas shortages and delays in cost pass-through in the fourth quarter of 2017, CR Gas' dollar margin fell to Chinese renminbi (RMB) 0.58/ cubic meter (cbm) (excluding value-added tax [VAT]) in 2017, from RMB0.71/cbm in 2016. The gross margin fell to 30%, from 34% in 2016.

We expect CR Gas' dollar margin in 2018 to remain stable. As part of the market liberalization process, the National Development and Reform Commission (NDRC) of China announced another new regulation for city-gate gas prices for residents with commercial and industrial gas use, effective June 10, 2018. We anticipate that most of the cost hikes will be eventually passed through to residents because the overall impact to each household will be limited. However, the pass-through could be delayed because it requires a public hearing process, potentially leading to a minor margin squeeze for CR Gas.

Gas demand and growth in gas sales volume in China will likely remain strong in 2018-2020. China's ongoing promotion of the use of natural gas as a replacement for coal, and the government's clean heating initiatives for northern China will stimulate gas demand and penetration. In 2017, CR Gas' sales volume grew 21% while nationwide natural gas consumption rose 15.3%.

In our view, CR Gas could use its strong free operating cash flows to make acquisitions and gradually increase dividend payouts. In addition, we believe the government's policy goal to reduce the burden on commercial and industrial end users of gas, and the evolving policy on connections fees could result in volatility in CR Gas' profitability.

We assess CR Gas as an insulated subsidiary to China Resources (Holdings) Co. Ltd. (CR Holdings). The insulation assessment primarily reflects our view that CR Gas has stand-alone operations and finance functions, and its funding channels and prospects are independent from those of the group to a certain extent. The company provides stability to the group's earnings, although its contribution is still small. Therefore, the parent has compelling economic incentives to preserve the subsidiary's credit strength. In addition, given CR Gas' status as a listed entity, external monitoring and corporate governance requirements will protect the company from negative intervention by the parent.

The stable outlook on CR Gas reflects our expectation that the company will continue to generate stable cash flows over the next two years with a prudent approach to capital expenditure. The outlook also reflects our view that CR Holdings will maintain a stable group credit profile.

We could downgrade CR Gas if: