Fitch Ratings has affirmed China Metallurgical Group Corporation's (CMGC) Long-Term Foreign-Currency Issuer Default Rating (IDR) and senior unsecured rating at 'BBB+'.

The Outlook is Stable. At the same time, Fitch has affirmed the Long-Term IDR and senior unsecured rating on CMGC's 49.18%-owned subsidiary, Metallurgical Corporation of China Limited (MCC), at 'BBB+' with a Stable Outlook.

CMGC's ratings are equalised with those of its parent, China Minmetals Corporation (BBB+/Stable), using a top-down approach as per Fitch's Parent and Subsidiary Linkage (PSL) Rating Criteria, in light of CMGC's strong operational and strategic linkage with Minmetals. Minmetals is rated on a top-down basis from the Chinese sovereign (A+/Stable) under our Government-Related Entities Rating Criteria.

MCC's ratings are equalised with those of CMGC due to strong operational and strategic linkages under the PSL criteria. The two companies are an integrated entity and share the same management team. The Stable Outlook reflects Fitch's expectation that linkages between Minmetals, CMGC and MCC will remain strong.

Key Rating Drivers

Minmetals Linked to State: Fitch assesses Minmetals' status, ownership and control by the central government as 'Strong' due to the government's full ownership and control and the company's high strategic importance to the state as a backbone capital investment company. We assess Minmetals' support record as 'Strong', as it has received substantial and consistent tangible support from the state in the form of capital injections and subsidies.

We assess the socio-political implications of a default by Minmetals as 'Moderate'. Its large operating scale and extensive coverage mean a default would cause a temporary domestic shortage in base materials, but other base-metal suppliers would fill the gap in the long run. The financial implications of a default are 'Strong'. Financial distress would limit funding for other state-owned enterprises, as Minmetals and its subsidiaries are active domestic and offshore bond issuers.

Strong Linkage with Parent: CMGC is wholly owned by Minmetals and is the parent's most important subsidiary, accounting for around half of Minmetals' revenue and assets, and around 40% of its EBITDA in 2021. CMGC, the engineering and construction (E&C) arm of Minmetals, collaborates with Minmetals in the construction of metallurgical projects, construction-material logistics, equipment manufacturing, and resource development.

Largest Metallurgical E&C Firm: CMGC is a market leader in China with a 90% share of contract value in the domestic metallurgical E&C sector and almost 60% globally. It has used its expertise in metallurgical projects to expand into property construction and municipal infrastructure, including integrated underground utility tunnels and smart cities, given the limited market for metallurgical projects and as part of its diversification efforts to lower concentration risks. Metallurgical engineering and infrastructure contracts accounted for 12% and 20% of its new contracts, respectively, in 2021.

Revenue Growth to Moderate: We project CMGC/MCC's overall revenue growth to fall to below 10% in 2022, down from around 25% in 2021, as construction activities were hindered by strict Covid-related policies and investment in property projects continues to weaken. Revenue growth in 2023-2025 could further lower to mid-single digits, since new contract growth has slowed to 5% in 9M22, from 18% in 2021 and 29% in 2020.

Margin Contraction amid Property Weakening: CMGC/MCC's overall EBITDA margin is likely to weaken to 4.5% in 2022 from 5% in 2021, mainly due to margin and scale contraction in the property sector. We expect sector revenue to fall by 15% in 2022 and margins to narrow to 11%, from 18% in 2021, amid industry-wide weakness. This would lead to a dip in the sector's EBITDA contribution from CMGC/MCC to 4% in 2022, from 9% in 2021. We expect property revenue to go down further in 2023 while margin stabilises, but the impact on CMGC/MCC's financial profile will be minimum given its small contribution.

Stable Leverage Profile: We believe CMGC/MCC's leverage will stay largely stable at 5x-6x over 2022-2025, with a temporary increase in 2022 due to weaker EBITDA generation. CMGC's and MCC's leverage, as measured by net debt to EBITDA, modestly improved in 2021 to 5.6x and 5.0x, respectively (2020: 6.4x and 5.6x). The improvement was partially due to working capital changes and controlled equity investment in public-private partnership (PPP) projects.

Fitch notes that the net increase in long-term equity investment, which we believe includes equity investment in PPP projects, has reduced to CNY3.4 billion in 2021, from CNY3.9 billion in 2020 and CNY8.0 billion in 2019. We estimate that this amount will be around CNY4.0 billion each year in the next few years.

Derivation Summary

CMGC's rating reflects Fitch's assessment of the credit profile of its parent, Minmetals, and the two entities' strong linkages. CMGC plays a vital role in the vertical integration of Minmetals, whose rating is three notches below China's 'A+' rating. CMGC's rating is the same as that of Power Construction Corporation of China (BBB+/Stable) and China Energy Engineering Corporation Limited (BBB+/Stable), which serve a similar function for the Chinese government.

MCC's ratings are equalised with its parent, CMGC, due to their strong operational and strategic linkages. The two companies are an integrated entity and share the same management team. MCC accounts for almost all of CMGC's revenue, EBITDA, debt and cash.

Key Assumptions

Fitch's Key Assumptions Within Our Rating Case for CMGC

Revenue growth of 9%, 5%, 6% and 6% over 2022-2025 (2021: 25%)

EBITDA margin of around 4.5% in 2022-2025 (2021: 5.1%)

Capex of CNY4 billion-5 billion each year over 2022-2025 (2021: CNY3.6 billion)

Equity investment in PPP projects of CNY4.0 billion per year in 2022-2025

Fitch's Key Assumptions Within Our Rating Case for MCC

Revenue growth of 9%, 5%, 6% and 6% over 2022-2025 (2021: 25%)

EBITDA margin of around 4.5% in 2022-2025 (2021: 5.0%)

Capex of CNY4 billion-5 billion each year over 2022-2025 (2021: CNY3.6 billion)

Equity investment in PPP projects of CNY4.0 billion per year in 2022-2025

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to positive rating action/upgrade:

Positive rating action on Minmetals

Factors that could, individually or collectively, lead to negative rating action/downgrade:

Negative rating action on Minmetals

Weakening linkage between Minmetals, CMGC and MCC

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

Adequate Liquidity: CMGC had CNY68 billion of short-term debt at end-2021 (including the current portion of perpetual notes and factoring in liabilities based on Fitch's definition), which can be covered by CNY32 billion of available cash and around CNY416 billion of unutilised bank facilities.

MCC reported CNY60 billion in short-term debt at end-2021 (including the current portion of perpetual notes and factoring in liabilities based on Fitch's definition), which can be covered by CNY31 billion of available cash and over CNY470 billion of unutilised bank facilities.

These facilities are uncommitted, as committed credit facilities are not common in the Chinese banking environment. CMGC and MCC both have extensive relationships with onshore and offshore financial institutions, and sound records in refinancing short-term debt.

Issuer Profile

MCC and CMGC are among the leading construction companies in China. CMGC is 100% owned by Minmetals, a central state-owned enterprise. CMGC was merged into Minmetals in December 2015 following the mandate of the State-owned Assets Supervision and Administration Commission of the State Council. MCC is listed on the Shanghai Stock Exchange and 49.18% owned by CMGC as of June 2022.

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.

ESG Considerations

Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg

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