Fitch Ratings - Hong Kong/Shanghai - 05 Feb 2024: Fitch Ratings has upgraded China-based Sichuan Development Holding Co., Ltd.'s (SDH) Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDRs) to 'A' from 'A-' and removed the ratings from Under Criteria Observation (UCO).

The Outlook is Stable. Fitch has also upgraded to 'A' from 'A-' the USD2 billion medium-term note programme and the USD500 million 2.8% senior unsecured notes due 2026 issued under the programme by its wholly owned subsidiary, Yieldking Investment Limited

The notes are unconditionally and irrevocably guaranteed by Sichuan Development International Holding Company Limited (SDIH), SDH's fully owned subsidiary. SDH has also granted a keepwell and a deed of equity interest purchase undertaking to ensure SDIH has sufficient assets and liquidity to meet its guarantee obligations. The note rating is linked to our internal credit assessment of SDIH, which is assessed as a financing vehicle of SDH based on our Government-Related Entities (GRE) Rating Criteria.

The upgrade is the result of a higher support score assessment for SDH after the publication of Fitch's final Government-Related Entities Rating Criteria and Public Policy Revenue-Supported Entities Rating Criteria on 12 January 2024. We raised our assessment to 'Very Strong' for contagion risk from the 'Strong' assessment of the financial implications of default under the previous criteria.

KEY RATING DRIVERS

Support Score Assessment 'Virtually certain'

The support score is a combination of our assessment of the government's responsibility and incentive to support.

Responsibility to Support

Decision Making and Oversight 'Very Strong'

The Sichuan government controls SDH, with 90% of its shares held by the Sichuan State-owned Assets Supervision and Administration Commission (SASAC) and 10% by the Sichuan Provincial Department of Finance. The local government is the key decision-maker on major events and imposes specific requirements on key operations. SDH has to submit its operational and financial performance reports as well as budget completion reports regularly. The government sets the performance appraisal indicators for SDH's senior management and conducts evaluations on an annual basis.

Precedents of Support 'Strong'

Most of the provincial government's support has been geared towards SDH's transport infrastructure and power generation subsidiaries to facilitate their capital-intensive investments. The support is primarily via capital injections and tax revenue transfers, as well as special funds and interest subsidies to enhance SDH's financial flexibility. Total support from 2018-2022 reached CNY112.5 billion, or 23% of SDH's consolidated net assets, helping SDH to maintain its financial profile. The government also swapped railway-related debt of CNY6.5 billion with government bonds, easing SDH's financial pressure.

Incentives to Support

Preservation of Government Policy Role 'Strong'

SDH has high policy intensity and holds strategically important assets, which means a default of the company could be attributed to the provincial government's leadership, with grave political repercussions. A large portion of the portfolio held by SDH is infrastructure that is critical to the province, including railways, toll roads, power generators and local airline groups. Most of SDH's investees are dominant in their industries.

The company's consolidated profit before tax contributed more than 80% of the total profit before tax of the entities supervised by the Sichuan SASAC in 9M23. Its infrastructure assets are not likely to be liquidated if it defaults, but the loss of its shareholding in businesses such as power generation and other listed companies could significantly hamper the profitability of Sichuan's state-owned enterprises and job creation in the province. SDH's substantial financial contribution to the Sichuan SASAC would justify a rescue by the provincial government if the company is in distress.

Contagion Risk 'Very Strong'

SDH is assessed as a strategic investment holding company under our new criteria and, therefore, we do not regard the low proportion of its parent-level debt as a constraint on the factor assessment. Under the old criteria, the financial implications of a default were assessed as 'Strong' because its parent-level debt only made up about 13% of consolidated debt, which limited its position as a proxy financing vehicle for the Sichuan province.

Our new criteria consider SDH's role as the dominant shareholder in most provincial-level GREs, making it a reference issuer, which means investors regard its debt issuance as an indication of the provincial government's ability to access financing. Its total assets accounted for 75% of those directly supervised by the Sichuan government as of September 2023. The company is a frequent issuer in the domestic and offshore bond market and is able to obtain financing at the lowest cost among the GREs in the province. There have been no financial tensions to date.

Standalone Credit Profile

SDH's Standalone Credit Profile (SCP) of 'b+' is based on a 'Midrange' risk profile, 'b' financial profile, and high positioning among peers.

Risk Profile: 'Midrange'

Fitch assesses SDH's risk profile at 'Midrange', reflecting the combination of assessments below:

Revenue Risk: 'Midrange'

'Midrange' Demand Characteristics

Most of SDH's investees are geographically concentrated in the Sichuan province. Its investment portfolio has adequate cash flow-generating capability. It receives dividends every year, although with some fluctuations. A number of its investees, such as Shudao, Sichuan Road & Bridge and Yangtze Power, make regular public disclosures as they are listed on the stock market or issue public bonds.

'Midrange' Pricing Characteristics

SDH, as the controlling shareholder of many investees, has the capacity to increase its dividends, although this may affect the quality of its assets if the increase is frequent. Adjusted revenue has been stable, which also points towards 'Midrange' pricing characteristics.

Expenditure Risk: 'Midrange'

'Midrange' Operating Costs

SDH has strong access to the capital market, as well as adequate financial resources in the province, as Sichuan is western China's financial and logistical hub. Bond tenors are typically five, seven or 10 years, longer than that of most industry peers. Its borrowing costs on the parent level were consistently lower than the prevailing benchmark rate.

'Midrange' Investment Planning

SDH has a mechanism for investment planning throughout the different stages of investment life. Exits or cashing out of investments have not been frequent as most of its stakes are meant to be held for the long term. Impairment losses have been moderate. Most of its portfolio companies can achieve self-sufficiency in cash flow.

Liabilities and Liquidity Risk: 'Midrange'

We assess both debt and liquidity characteristics as 'Midrange'. SDH had a relatively balanced maturity profile at end-September 2023. Most of its bonds are long term and carry tenors of three, five, seven or 10 years. It also has a US dollar bond issued by SDIH, with a keepwell from SDH, which is due in 2026. Off-balance-sheet risk remains manageable. SDH has good access to financial markets and adequate liquidity.

Financial Profile 'b'

SDH's parent-level financial profile is assessed at 'b', mainly constrained by its stretched leverage of 23.2x at end-2022, higher than the threshold of 18x. Leverage is likely to stay at a slightly higher level in 2023-2027. Its loan-to-value ratio was 62.6% at end-September 2023 and we expect it to stay stable.

Derivation Summary

SDH is rated under Fitch's Government-Related Entities Rating Criteria and is credit-linked to our internal assessment of the creditworthiness of the Sichuan province. SDH's IDRs are derived from the four factors under the Government-Related Entities Rating Criteria and the 'b+' SCP under Fitch's Public Policy Revenue-Supported Entities Rating Criteria.

Debt Ratings

The 'A' rating on SDH's USD2 billion medium-term note programme and USD500 million 2.8% drawdown due 2026 is equalised with its IDR. The programme and the notes under the programme are issued by SDH's SPV, Yieldking Investment, and unconditionally and irrevocably guaranteed by SDIH. SDH also provides a keepwell to SDIH and Yieldking.

The instrument ratings are linked to Fitch's internal assessment of SDIH in light of the guarantee. The internal assessment of SDIH is derived under Fitch's new GRE criteria.

Issuer Profile

SDH is a wholly state-owned company founded by the Sichuan provincial government in December 2008. It is the sole provincial-level state-owned capital investment and operation platform in Sichuan and the largest provincial-level state-owned enterprise with total assets of CNY1.9 trillion by end-September 2023. Its total assets accounted for 75% of the total assets directly supervised by the provincial government by end-September 2023.

Summary of Financial Adjustments

Fitch has reclassified SDH's parent-level investment income as recurring income and included it in the calculation of EBITDA, to reflect the nature of SDH as a strategic investment holding company.

Rating Sensitivities

Factors that Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade

A significant weakening of the contagion risk of a default, or deterioration in our assessment of the government's precedents of support or preservation of government policy role, or a dilution of the government's control or weaker oversight;

A deterioration of Sichuan's fiscal strength and debt-servicing capability, leading to a lowering of Fitch's credit view of the province's ability to provide support or other legitimate resources allowed under China's policies and regulations.

Factors that Could, Individually or Collectively, Lead to Positive Rating Action/Upgrade

Improvement in Fitch's internal assessment of the Sichuan province's ability to provide support or other legitimate resources allowed under China's policies and regulations.

ESG Considerations

The highest level of ESG credit relevance is a score of '3', unless otherwise disclosed in this section. A score of '3' 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. Fitch's ESG Relevance Scores are not inputs in the rating process; they are an observation on the relevance and materiality of ESG factors in the rating decision. For more information on Fitch's ESG Relevance Scores, visit https://www.fitchratings.com/topics/esg/products#esg-relevance-scores.

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