OREANDA-NEWS. Fitch Ratings has affirmed China-based ENN Energy Holdings Limited's (ENN) Long-Term Issuer Default Rating (IDR) and its senior unsecured rating at 'BBB'. The Outlook is Stable.

The rating is underpinned by favourable government policies towards the city gas distribution sector in China, ENN's strong business profile and its sound credit metrics.

KEY RATING DRIVERS
Strong Operating and Financial Performance: ENN's revenue rose 26.7% to CNY29.1bn and EBITDA climbed 10.6% to CNY4.5bn in 2014. ENN operated 142 projects at end-2014, compared with 134 a year earlier. Its residential connections rose 14.3% to 10.6 million and commercial and industrial (C&I) connections increased 22.5% to 47,689 at end-2014. Fitch expects ENN's business to continue to be supported by increased use of natural gas in China. Gas use, however, will grow at a slightly slower rate in the next five years than in the last decade because of the higher base, and slower economic growth.

Gas Sales' Contribution Increasing: Fitch estimated that EBITDA from sale and distribution of gas fuel and related products rose to about HKD3.1bn in 2014 from HKD2.8bn in 2013. Although the increased contribution of lower margin recurring gas sales may have narrowed the overall profit margin of the company, the higher contribution to EBITDA from gas sales is positive because gas sales are more stable than gas connection fees. This is a trend we have observed across the leading operators as the industry matures.

Dollar Margin Maintained: ENN has maintained the dollar margin on gas volume sold through price adjustments, despite delays in certain areas. Fitch expects the stability of crude oil prices at lower levels to reduce cost pass-through risks and delays for city gas operators, provided the current pricing mechanism remains unchanged. China's National Development and Reform Commission (NDRC) announced two price adjustments in September 2014 and April 2015 in the past year. The price adjustments were broadly in line with NDRC's mechanism to price natural gas prices sold to city gas operators based on the price of a basket of energy products, mainly crude oil and LPG.

Evolving Business Profile: ENN is slowly moving away from being a pure city-gas operator in China because it has been investing in new growth opportunities, which carry higher business risks. ENN has stepped up investments in compressed natural gas (CNG) and liquefied natural gas (LNG) gas stations through investing in Sinopec Marketing and acquiring North American assets from related parties. In the short to medium term, the agency does not expect these new ventures to negatively impact ENN's ratings, unless ENN aggressively increases its investment outside of city gas operations in China or non-city-gas operations become meaningful to ENN's business profile.

Robust Credit Metrics: We expect ENN to maintain credit metrics appropriate for its 'BBB' ratings, barring any material increase in investments or cash returns to shareholders. Fitch expects ENN's funds flow from operations (FFO) to adjusted debt to continue to remain around 4x (2014: 4.8x), FFO net leverage to remain around 2x (2014: 1.5x), FFO fixed charge coverage to be maintained at over 4x (2014: 5.7x), and free cash flows to remain neutral to negative in the medium term, driven by elevated capex as the company invests in expanding its city gas operations and its LNG refuelling station footprint.

KEY ASSUMPTIONS

Fitch's key assumptions within our rating case for the issuer include:
- Gas sales volume growth remains in the mid-teens
- Turnover from connection fees remains stable
- Dollar margin remains stable, that is, increase or decrease from gas procurement costs are passed through to end-users
- Capex at above historical levels
- Neutral to positive free cash flow before acquisitions and non-city gas capex

RATING SENSITIVITIES
Positive: Future developments that may, individually or collectively, lead to positive rating action include:
- 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 break-even on a sustained basis
- clearer regulatory regime, continued demonstration of the company's ability to pass through cost increases without materially affecting margins, and the overall business risk profile not weakening due to investments outside of the city gas distribution business

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
- FFO fixed charge coverage lower than 4x on a sustained basis
- Expansion into non-city gas businesses that will materially change the company's business risk profile
- 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.