OREANDA-NEWS. Fitch Ratings has affirmed city piped gas distributor China Resources Gas Group Limited's (CRG) Long-Term Issuer Default Rating (IDR) at 'BBB+' with a Stable Outlook. CRG's senior unsecured rating is also affirmed at 'BBB+'.

CRG's IDR incorporates a one-notch uplift for potential support from its immediate parent, China Resources Holdings Limited (CRH), which owns 64% of CRG. CRH is wholly owned by the State-owned Assets Supervision and Administration Commission (SASAC) of China (A+/Stable). CRG's standalone 'BBB' rating reflects its diversified operations, its strong credit metrics and liquidity, robust industry fundamentals as well as risks associated with the city gas industry in China.

KEY RATING DRIVERS

Strong Operating and Financial Performance: CRG, together with other large city-gas operators in China, continued to expand their operational footprint and increase gas sales volumes and new connections in 2015, despite slower gas demand growth in China. CRG's revenue rose 8.3% to HKD31.1bn and EBITDA increased 8% to HKD5.6bn in 2015. The company increased its number of city-gas projects to 220 at end-2015 from 205 a year earlier with connected residential users up 13.8% to 23.6 million and commercial & industrial (C&I) users up 22% to173,846 during the year.

Slower, but Steady Demand Growth: Fitch expects CRG's gas sales to increase at a low double-digit percentage pace, which is slower than previous expectations, to reflect the slower energy consumption growth in China in the longer term. China's overall gas consumption growth has recovered so far in 2016, helped by the city-gate-level gas price cut in November 2015, which made gas more competitive against other fuel sources, such as coal and oil, whose prices have fallen.

China's gas consumption increased 10.6% in the first five months of 2016 compared with the same period last year and 5.7% in 2015. While this significant uptick in demand was supported by higher demand during the last winter, we believe China's overall gas demand will continue to increase at 6%-7% a year. Fitch expects CRG's gas volume growth to continue to be supported by the increased use of natural gas in China and relatively low natural gas penetration. Within CRG's regions of operation, natural gas penetration was at 44.4% at end-2015; this is lower than that of its peers, and provides greater organic growth prospects for the company.

Dollar Margin Maintained: CRG's dollar margin on the sale of gas, measured by EBITDA per cubic meter of gas (cbm), has remained broadly stable with city-gas operators able to pass through changes to city-gate level prices implemented by China's National Development and Reform Commission, albeit with a time lag. Fitch estimates the EBITDA dollar margin in 2015 was around CNY0.27 per cbm compared with CNY0.26 per cbm in 2014. This margin has increased over time as its projects matured. Maintenance of the dollar margin is key to the financial profile of city gas operators, as this is an important indicator of a city-gas operator's ability to pass through fuel cost increases to its customers, especially as there is no clear regulation protecting city-gas operator's returns.

There have been some isolated incidents of provincial-level intervention in city-gas prices, such as those announced by Zhejiang Province, in May. However, we do not expect such interventions to be a material risk for the sector. (see Fitch: Zhejiang Price Cap has Little Impact on City Gas Operators)

High Capex in Short-Term: The high capex programme in the short term aims for organic growth - CRG's management believes natural gas penetration within its footprint is still low. In addition, CRG's management plans to inject capital into project companies to increase ownership and control, as the company has done in the last few years. Greater control of these projects reduces structural cash flow subordination, although they add to the company's investment outlays. These opportunities will require the company to maintain a large cash reserve. The management says inorganic growth will taper off after 2018.

Improving Robust Credit Metrics: Notwithstanding the capex and acquisition outlays, CRG's credit metrics are likely to remain strong for its 'BBB' standalone profile. Fitch expects FFO gross leverage to fall below 3x in the next 18-24 months (2015: 3.6x; FFO-adjusted net leverage is already comfortably below 2x and is likely to remain so) and fixed-charge coverage to remain above 6x (2015: 6.5x).

In Fitch's view, the company has demonstrated strong financial discipline and we expect the company to continue to focus on its core city-gas operations. However, given the investments in capex and M&A (including for increasing ownership of existing projects), CRG's free cash flows after capex, acquisitions and dividends are not likely to turn positive before 2019. This constrains any positive revision of the company's 'BBB' standalone profile.

KEY ASSUMPTIONS

Fitch's key assumptions within our rating case for the issuer include:

- Gas sales volume growth remains in the low double digits

- Turnover from connection fees remains stable

- Dollar margin remain stables, that is, increase or decrease in gas procurement costs are passed through to end-users

- Capex, capital injections into project companies and acquisitions remain high

RATING SENSITIVITIES

Positive: Future developments that may, individually or collectively, lead to positive rating action include:

Standalone credit profile (Currently 'BBB')

- Continued demonstration of the company's ability to pass through cost increases without materially affecting margins; and

- FFO-adjusted gross leverage lower than 3x and FFO fixed-charge coverage higher than 6x, on a sustained basis;

- Free cash flows after capex, acquisitions and dividends at least reaching broadly breakeven on a sustained basis;

- The overall business risk profile not weakening due to investments outside of the city-gas distribution business

Issuer Default Rating

- Positive revision of the company's standalone profile may not lead to an upgrade of the 'BBB+' IDR

Negative: Future developments that may, individually or collectively, lead to negative rating action include:

- FFO-adjusted net leverage higher than 4x on a sustained basis; and

- FFO fixed-charge coverage lower than 4x on a sustained basis; or

- A material deterioration in the regulatory environment or worse-than-expected weakening of profitability of the city-gas distribution operations, which may arise from not being able to translate higher gas procurement costs into higher tariffs; or

- weakening of the effective linkages with its parent China Resources Holdings Limited, and SASAC