OREANDA-NEWS. August 31, 2015. Fitch Ratings has today said China Shenhua Energy Company Limited's (China Shenhua, A+/Stable) financial profile has deteriorated due to the continued weakness in coal markets in China and the region. However, the company's unique and effective vertical integration - from power generation to railway assets - has helped to soften the impact on cash generation compared with other coal miners.

China Shenhua's vertical integration, and the stability that it provides, are the key factors underpinning its strong 'A' category standalone credit profile. The Issuer Default Rating of 'A+' on China Shenhua, China's largest coal producer by annual coal production volume, incorporates state support.

China Shenhua reported a 29% and 25% drop in total revenue and EBITDA for the six months ended June 2015 (1H15), with coal production and sales, traditionally the largest operating segment, registering a substantial drop, similar to other miners. The company's coal sales volume and price dropped by 24% and 12% respectively due to sluggish demand from coal-fuelled power plants and industrial users. Its own coal production also fell 10%; we believe leading state-owned miners may have cut production to help reduce the severe oversupply in China's coal market. As a result, revenue and EBTIDA of the coal segment dropped 40% and 46%, respectively in 1H15.

However, China Shenhua's vertical integration model helped to dilute the impact of weak performance of its coal segment. China Shenhua's power plants - mostly coal-fuelled - are an effective natural hedge when coal prices fall. In 1H15, the power generation segment reported a stable EBITDA despite weak power sales, thanks to a 14% decrease in unit fuel costs. As a result, the power generation segment contributed 39% of the company's total EBITDA exceeding the 28% contribution from coal mining in 1H15. However, it is possible that China may trim tariffs for coal-fired electricity amid sustained low coal prices and the weak economic growth, which could negatively affect profits from power generation if there was no meaningful uptick in power sales. Other segments, such as railways, ports and coal chemicals, also reported much smaller reductions in profits compared with coal mining.

Fitch expects China Shenhua's financial profile to remain weaker compared with that in 2014, given our expectation of weak coal prices in the next 12-18 months. We also expect the company to trim its capex and record neutral to slightly negative free cash flows. We forecast the company's funds flow from operations (FFO)-adjusted net leverage to rise to around 1.3x by 2016 (0.9x at end-2014), a level that it still appropriate for its 'A' standalone ratings, which take into account its business strengths arising from its vertical integration as well as its position in China.