OREANDA-NEWS. Fitch Ratings has assigned Baoshan Iron & Steel Co. Ltd's (Baosteel; A-/Stable) proposed euro-denominated notes an expected 'A-(EXP)' rating. The proposed notes are issued by Bao-Trans Enterprises Ltd (Bao-Trans), a wholly owned subsidiary of Baosteel.

In place of a guarantee, Baosteel has granted an investment and keepwell deed, and a liquidity support covenant deed to ensure that Bao-Trans has sufficient assets and liquidity to meet its obligations for the proposed notes.

Baosteel's investment and keepwell deed is a channel to provide liquidity to the issuer when needed through equity investment or shareholder's loan or a combination of the two. In addition, under the liquidity support covenant deed, Baosteel will provide a standby facility to cover amounts due under the bonds if needed, and liquidity to Bao-Trans when needed by adjusting the settlement policy for transactions between the two, including reducing the repayment period of any trade receivables due to Bao-Trans from Baosteel, or extending the prepayment period of any trade advances to Bao-Trans from Baosteel.

Baosteel's ratings are equalised with its parent Baosteel Group Corporation's (Baosteel Group; A-/Stable) due to the strong operational and strategic linkages to its parent, which in turn benefits from a one-notch uplift associated with potential government support. Baosteel on a standalone basis has a credit profile that is more reflective of a 'BBB+' rating.

The final rating on the proposed notes is contingent upon the receipt of documents conforming to information already received. Net proceeds from the issue will mainly be used for refinancing, capital expenditure and/or working capital and other general corporate purposes.

KEY RATING DRIVERS
Potential Support from State: Baosteel and its parent are leaders among China's steel companies, spearheading high-tech steel-product development in the country. Baosteel is also the strongest steel company financially in China. The State-owned Assets Supervision and Administration Commission of the State Council (SASAC) is the overall parent, so the group is well-placed to strengthen China's steel industry development.

Financially Stronger than Peers: Baosteel maintains a stronger financial profile relative to domestic and global peers. It remains the most profitable Chinese steel producer in absolute terms as well as based on metal spread, defined as gross profit per ton of steel product sold. Baosteel has the strongest financial position compared with leading global steel producers.

Effective Business Strategy: Strong business discipline has kept Baosteel focused on maximising its core competency, which includes technological development, integrating steel operations for better synergies, and selective expansion into growth markets. That helps to improve overall business stability for the group under the current weak steel industry environment through superior product mix and sufficient raw material supplies.

Weak Industry Constrains Ratings: Baosteel's ratings have been weighed down by excess capacity and volatile raw material costs in the industry, which have kept profit margins thin since 2011. The excess capacity is at risk of overshooting China's steel consumption potential, leading to a chronic excess of global steel supply. However, debt-servicing pressure is pushing steel producers to scale back their capex plans. Baosteel, being the most efficient in the industry, is likely to be among the first to benefit from an expected earnings recovery in 2016, which will result from a significant increase in iron-ore supply that pushes raw material costs lower.

RATING SENSITIVITIES
Rating sensitivities below are applicable to Baosteel Group as Baosteel's ratings are equalised to Baosteel Group's.

Negative: Future developments that may, individually or collectively, lead to negative rating action include:
- weakened linkage with the state
- sustained decline in metal spread (gross profit per ton of steel product sold) below CNY400;
- FFO-adjusted net leverage exceeding 3.0x on a sustained basis (Fitch forecast for 2015: below 3.2x; for 2016: below 3.0x)

Positive: Although Fitch does not envisage taking positive rating action in the next 12-18 months as the industry continues to rationalise excess capacity, future developments that may, individually or collectively, lead to positive rating action include:
- substantial improvement in the steel industry via consolidation and easing raw material constraints
- improved business profile in terms of product leadership across more industries and geographic expansion while maintaining a strong financial profile
- consistent free cash flow generation