Fitch Ratings - Hong Kong/Shanghai - 30 Apr 2020: Fitch Ratings has affirmed Beijing Gas Group Co., Ltd.'s (Beijing Gas) Long-Term Issuer Default Rating (IDR) and senior unsecured rating at 'A'.
The Outlook is Stable.
Fitch has also affirmed the 'A' rating on Beijing Gas' USD500 million 2.75% senior unsecured bond due 2022. The bond is issued by Beijing Gas' wholly owned subsidiary, Beijing Gas Singapore Capital Corporation, and guaranteed by Beijing Gas.
Beijing Gas' ratings are aligned with Fitch's internal credit assessment of the company's immediate parent, Beijing Enterprises Holdings Limited (BEHL), which fully owns Beijing Gas. BEHL's credit profile is linked to that of its parent, Beijing Enterprises Group Co., Ltd. (BEG), which is in turn linked to, but not equalised with, the Beijing municipality, to reflect the strong likelihood of government support, according to Fitch's Government-Related Entities Rating Criteria. Fitch sees strong operational and strategic linkages between BEG and BEHL, and between BEHL and Beijing Gas, per our Parent and Subsidiary Rating Linkage criteria.
We expect the coronavirus pandemic to slow the company's gas sales growth in 2020, but the impact will be small, as its exposure to commercial and industrial (C&I) customers is low and the extended heating season in Beijing also boosted demand. Beijing Gas' profitability will be supported by its strong cost pass-through ability that prevents material dollar margin compression from a reduction in non-residential retail gas prices from 22 February to 30 June due to the coronavirus. Beijing Gas may also reap cost savings from plunging liquefied natural gas (LNG) prices, as it made small purchases of spot LNG in the international market.
Dividends from Beijing Gas' investment in the Shaanxi-Beijing gas pipelines (SJ Line) will also be stable, as their utilisation is unlikely to be impaired by the pandemic in light of their strategic function in ensuring Beijing's energy security. Dividends from its oil and gas investment in Russia will be much lower due to weaker oil prices, but the overall impact will be manageable due to its small contribution and Beijing Gas' strong financial position. We will review our assumptions if the pandemic is prolonged and has a material impact on the company.
KEY RATING DRIVERS
Rating Aligned With Parent: Beijing Gas is 56%-owned by BEG through BEHL. It is the largest cash flow contributor to BEHL and is the listing platform that holds most of BEG's strategic assets. Beijing Gas' funds from operations (FFO) accounted for 70% of BEHL's in 2019. Beijing Gas' strategic importance to its parents is underpinned by its role as the major executor of the key policy mandates entrusted by the local government to BEG. It has received substantial tangible support from both BEHL and BEG in the form of dividend waivers, internal funding support and a counter-guarantee for a sovereign loan.
Major Executor of Gas Mandates: Beijing Gas plays a key role in securing the capital's gas supply and facilitating rural coal-to-gas transition as the municipality pushes for a cleaner environment and higher gas consumption. It supplied over 95% of Beijing's gas usage in 2019.
Beijing Gas is also responsible for developing, maintaining and expanding Beijing's gas network and securing supply at a reasonable cost. It was delegated to build two LNG storage tanks in Caofeidian, Tangshan. It was also entrusted to build an LNG terminal project in Nangang, Tianjin, starting 2020, which comprises LNG storage tanks, one LNG pier with capacity of 5 million tonnes/year and an outbound transmission pipeline that connects to Beijing. Both projects are part of a comprehensive emergency energy-supply system to meet the region's surging gas demand and alleviate a supply shortage in winter.
Strong Tangible Support: Beijing Gas' total direct subsidies from the Beijing Department of Finance since the start of its rural coal-to-gas conversion projects in 2015 exceeded CNY1 billion by end-2019, compensating for 30% of the projects' total capex. Beijing Gas also received government cash injections for key infrastructure construction projects, and secured a sovereign-guaranteed loan from Asia Infrastructure Investment Banks to fund the construction of the Nangang LNG project, evidence of the strong support due to its strategic importance.
BEHL Aligned with BEG: BEHL's credit profile is strongly linked to that of BEG, which owns 56% of BEHL. The linkage between BEHL and BEG is strong as BEHL holds BEG's most strategic utility assets, including natural-gas distribution, water and solid waste-treatment projects. BEHL also serves as an important funding platform for BEG with access to overseas equity and debt markets.
Strategic Importance of BEG: BEG is fully owned by the Beijing State-Owned Assets Supervision and Administration Commission (SASAC) and serves as its key investment platform, with engagement in piped natural gas, liquefied petroleum gas, water and solid waste utilities, property development, instrument and control system manufacturing, trade and brewery. It also owns important infrastructure and utility operations, apart from Beijing Gas' policy mandates in energy security and rural coal-to-gas projects. It has received tangible support from Beijing SASAC through annual equity injections and subsidies.
Smooth Pass-Through; Regulatory Review: Beijing Gas' dollar margin was cut by only CNY0.026/cubic metre (cbm) in 2019, signalling a smooth cost pass-through. The drop reflected an average sales price (ASP) cut for C&I and power co-generation gas usage of CNY0.08/cbm and CNY0.1/cbm, respectively, after the adoption of a new gas distribution pricing mechanism in 2Q19 with lower distribution tariffs. The new mechanism, which calculates non-residential ASP with a procurement-plus-distribution-cost formula, helps to further reduce the company's price risk exposure. Nevertheless, we expect the company's dollar margin to narrow marginally following a regulatory review in April 2021, as the government aims to encourage gas usage and eliminate city-gate distributors' excessive returns in line with the 7% return-on-asset cap set by regulators.
Slower Volume Growth: Beijing Gas' gas sales volume in Beijing declined by 1% in 2019 due to a warmer winter that drove residential, and heating and cooling gas sales volume lower by 20% and 2%, respectively. However, gas volume on a consolidated basis was 3% higher, thanks to more robust growth from sales outside Beijing. Beijing Gas' sales volume fell 1% yoy in 1Q20, less than the 5%-15% drop for other Chinese city-gas operators. Beijing Gas' customer mix, dominated by residential, power cogeneration and heating usage, is less cyclical, while the incremental gas usage from the mandatory extension of the heating season by 15 days in March also helped to boost consumption. We expect volume to resume decent growth as the pandemic eases, but do not envisage demand to materially rebound until 2021.
Strong FFO; Uncertainties from Spin-off: Beijing Gas' operating cash flow generation is more stable than that of many other rated Chinese gas operators, as it does not charge gas-connection fees, which we see as non-recurring. Beijing Gas also has stable dividends from its 40% stake in SJ Line, one of the most used pipelines in China, boosting its asset-based returns. SJ Line's dividend made up 24% of Beijing Gas' FFO in 2019, while most other rated Chinese gas operators do not own defensive pipeline assets that underpin cash flow stability.
The timing and deal structure of SJ Line's potential spin-off to the newly established China Pipeline Corp remain uncertain. The impact on Beijing Gas' credit profile cannot be assessed until more details on the transaction become available. We expect its 40% shareholding in SJ Line to remain intact, but the spin-off may affect the timing of the dividends. However, the cash impact on Beijing Gas from delayed dividend receipts can be mitigated by a potential deferral of its share of capex payments for SJ Line, as in 2016. The company will retain a net cash position in 2021 even if it does not receive dividends from SJ Line, provided its 40% shareholding remains intact.
Weak Oil Prices Manageable: VCN, an oil company operating in east Serbia in which Beijing Gas owns a 20% stake, contributed 17% of Beijing Gas's FFO in 2019. We expect the cash contribution from VCN to drop by 5% in 2020, as oil prices plunge and Russian producers' agreement on production target cuts will translate into a full-year production drop of 8%-10%. The overall cash impact will be small given Beijing Gas' abundant buffers and robust cash inflow from SJ Line and city-gas distribution. We expect the impact from weak oil prices to be mostly reflected in 2021, as dividends to be received in 2020 include those declared in 2H19 when oil prices were still high.
Injections Ease Leverage; 'a-' SCP: FFO net leverage was -0.3x in 2019, in line with our forecast. We expect cash capex to rise to CNY6.6 billion in 2020 from CNY4.5 billion in 2019 and remain high at CNY 6.5 billion-9 billion per year until 2023, mainly driven by the construction of the Nangang LNG project. We expect free cash flow to turn negative in 2020 and not revert to positive until 2023, when the second phase of Nangang LNG is completed, but the pressure on leverage will be alleviated by government cash injections in 2020-2021. We therefore expect Beijing Gas to maintain a net cash financial position in 2020-2021 and its FFO net leverage to remain below 0.5x over the medium term. Its strong financials and business profile underpin its Standalone Credit Profit (SCP) assessment at 'a-'.
DERIVATION SUMMARY
Beijing Gas' ratings are linked to the credit profit of its parent, BEHL, which is in turn linked to the credit profile of BEG, based on Fitch's Parent and Subsidiary Rating Linkage criteria. BEG's ratings are linked to, but not equalised with, that of the Beijing municipality, according to Fitch's Government-Related Entities Rating Criteria.
KEY ASSUMPTIONS
Fitch's Key Assumptions Within Our Rating Case for the Issuer
Growth of gas sales volume below 0.5% in 2020, rebounding to low-single-digit growth in 2021-2023
Average gas sales price to decline in 2020 to reflect the temporary tariff cut for non-residential users in Beijing from 22 February to 30 June due to the coronavirus
Dollar margin to narrow by less than CNY0.02/cbm following the next regulatory review
Transmission tariffs of SJ Line to be compressed marginally in the upcoming regulatory review; utilisation to improve and reach 90% in 2023; dividend payments on SJ Line not delayed in 2020-2023
Oil price per Fitch's price deck; VCN production to drop by 12% in 2020; dividend payments from VCN not delayed in 2020-2023
Capex to stay high at around CNY7 billion, CNY9.5 billion and CNY7 billion in 2020, 2021 and 2022, respectively; new investments and acquisitions (including injections to joint ventures and associates) at around CNY800 million per year
Government cash injection of CNY2.65 billion-3 billion per year in 2020-2021
RATING SENSITIVITIES
Factors that could, individually or collectively, lead to positive rating action/upgrade:
An improvement in Fitch's internal assessment of the credit profile of BEG, provided the effective linkages between Beijing Gas and BEHL, as well as BEHL and BEG, remain intact
Factors that could, individually or collectively, lead to negative rating action/downgrade:
Weakening of Fitch's internal assessment of BEG's credit profile.
Weakening of linkages between Beijing Gas and BEHL, or between BEHL and BEG
BEST/WORST CASE RATING SCENARIO
International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.
LIQUIDITY AND DEBT STRUCTURE
Strong Liquidity: Beijing Gas had large unrestricted cash of CNY9.95 billion at end-2019, against short-term debt of CNY1.5 billion. We expect capex to rise materially in 2020, driven by the development of the Nangang LNG project, although 30% of the construction costs will be subsidised by the government. The company will have sufficient cash on hand to cover short-term debt and capex needs even if government cash injections run behind schedule. Its liquidity can be further supported by unutilised credit facilities of CNY330 million at end-2019.
SUMMARY OF FINANCIAL ADJUSTMENTS
The shareholder loans from BEG amounting to CNY2.74 billion (HKD3.05 billion) at end-2019 were not treated as debt according to Fitch's criteria.
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
PUBLIC RATINGS WITH CREDIT LINKAGE TO OTHER RATINGS
The ratings of Beijing Gas are aligned with Fitch's internal credit assessment of BEHL, per Fitch Rating's Parent and Subsidiary Rating Linkage criteria.
ESG CONSIDERATIONS
The highest level of ESG credit relevance, if present, is a score of 3. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity(ies), either due to their nature or to the way in which they are being managed by the entity(ies). For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg.
RATING ACTIONS
ENTITY/DEBT RATING PRIOR
Beijing Gas Group Co., Ltd. LT IDR A Affirmed A
senior unsecured
LT A Affirmed A
Beijing Gas Singapore Capital Corporation
senior unsecured
LT A Affirmed A
VIEW ADDITIONAL RATING DETAILS
Additional information is available on www.fitchratings.com
BEIJING ENTERPRISES HOLDINGS LIMITED 
