Fitch Downgrades Yancoal to 'BB-'; Outlook Negative
The downgrade of Yancoal's ratings and the Negative Outlook reflects the substantial deterioration of the company's cash generation capacity and credit metrics. Coal prices have continued to fall despite some production cuts across the industry. Fitch expects China coal prices to remain subdued for an extended period. In addition, further room for cost savings by Yancoal is fairly limited while its capital expenditure will remain elevated in the next two years, which will constrain its capability to deleverage.
Yancoal's good access to sources of funds and its strong liquidity buffer against its short-term obligations are the key factors supporting its 'BB-' IDR. However, there is little headroom under the revised ratings. The ratings would be vulnerable to negative action if coal prices fall further from current levels or if the company fails to increase production following the capex to expand capacity.
KEY RATING DRIVERS
Sustained Weakening of Coal Market: China's coal consumption in 2014 fell 2.5%, the first decline since 2001. Fitch does not expect any material recovery of domestic coal prices as the market will continue to be oversupplied for another two to three years with more new capacity being added. At the same time, coal demand will continue to be sluggish with a slowdown of industrial production and thermal power generation growth. In addition, thermal coal prices in China could come under more pressure after the government recently said it would cut the thermal power on-grid tariff by around 5%.
Weaker Credit Metrics: Yancoal's average realised selling price in 2014 dropped by 16%, faster than the reduction in costs, resulting in materially weaker profitability and cash generation. The company's EBITDA fell by a third. Funds flow from operations (FFO) gross interest coverage weakened to 2.1x at end-2014 from 4.0x at end-2013, and FFO adjusted net leverage rose to over 10x from 6.1x at end-2013.
Limited Room for More Cost-Savings: Yancoal has been actively cutting costs to cope with the adverse market conditions since 2013. In 2014, Yancoal managed to further reduce its average production cost by 9% per tonne of coal produced through production process optimisation and labour cost cuts. Fitch expects a good portion of these cost-cutting measures to be sustained in the short to medium term. However, with most of its cost-cutting options already exploited since 2013, there is unlikely to be further room for meaningful cost reduction.
High Capex to Continue: Despite the low coal prices, Yancoal is maintaining high capex to increase its production capacity, mainly in Inner Mongolia and Australia, in the medium term, which will continue to reduce its cash holdings in the next two years. In 2014, the company reported modest total capex of CNY5.4bn (2013: CNY9.1bn) due to delays in expansion projects and equipment delivery. However, Yancoal has budgeted CNY9.7bn capex for 2015, close to historical highs, to accelerate its expansion programme. Fitch expects Yancoal's capex level to remain elevated in the next two years till new projects in Ordos in China and Moolarben in Australia are completed, which would result in continued negative free cash flows.
Liquidity Still Adequate: At end-2014, Yancoal had over CNY15bn cash and CNY5bn term deposits on hand. These, together with operating cash generation, provide adequate cover for its total short-term debt of CNY11bn and planned capex of CNY9.7bn. The company has maintained a high cash position against possible financing difficulties, given the deteriorating financial performance of the coal mining sector. Yancoal's ample liquidity buffer, compared to 'B' category rated coal mining peers, is a key supporting factor for its 'BB-' IDR.
Linkages with Parent: Yancoal is 56.5% owned by Yankuang Group Corporation Limited (Yankuang), which is wholly owned by the Shandong State-owned Assets Supervision and Administration Commission (SASAC). The linkage is considered weak to moderate, and therefore, Yankuang's weaker credit profile does not constrain Yancoal's rating. The large number of institutions that are minority shareholders in Yancoal and the rules governing its listing on the Hong Kong Stock Exchange provide a meaningful counter-balance to Yankuang's controlling stake. Fitch has not provided any rating uplift to Yancoal on account of any implied support from the Shandong government. However, Yancoal benefits from good access to sources of funds due to its status as an entity majority-owned by the Shandong government.
KEY ASSUMPTIONS
Fitch's key assumptions within our rating case for the issuer include:
- average realised coal selling price to drop by 5% on average in 2015
- cost of coal sales per tonne to remain stable at the 2014 level
- new production from the Ordos and Moolarben projects to increase from 2015 and 2016, respectively
RATING SENSITIVITIES
Negative: Future developments that may individually or collectively lead to negative rating action include:
- FFO fixed charge coverage lower than 2.5x and failure to reduce FFO adjusted net leverage to or below 6x on a projected basis post-2016
- Sustained substantial negative free cash flow post-2016
- Weakening of the sizeable liquidity buffer Yancoal currently maintains with large cash balances
- Failure to ramp up production and improve profitability of Yancoal Australia as expected by Fitch
Positive Triggers: We do not expect any positive rating action in the medium term given our expectation of weak market conditions and Yancoal's limited headroom under the current rating. However, we may revise the Outlook to Stable at the current rating level if,
- The company can improve its credit metrics and liquidity such that its interest cover and financial leverage can be comfortably improved to beyond the negative guidelines listed above; and
- Attain at least near-natural free cash flows on a projected basis post-2016; and
- Maintain strong liquidity; and-Ramp up Yancoal Australia production volume and materially improve its profitability.
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