OREANDA-NEWS. Fitch Ratings has published Yunnan Provincial Energy Investment Group Co., Ltd.'s (YEIG) Long-Term Foreign-Currency Issuer Default Rating (IDR) and senior unsecured rating of 'BBB'. The Outlook is Stable.

Fitch has also assigned a 'BBB(EXP)' expected rating to the proposed US-dollar senior unsecured bonds to be issued by Yunnan Energy Investment Finance Co Ltd. YEIG will enter into a keepwell deed and deed of equity interest purchase & investment undertaking to provide credit support to the proposed bonds. The final rating on the bonds is subject to the receipt of final documentation conforming to information already received.

YEIG's ratings are credit-linked but not equalised with Fitch's internal credit assessment of Yunnan Province. The linkages between YEIG and Yunnan Province are evident in the province's majority effective ownership of the company and oversight of its management and strategies, the high strategic importance of YEIG's investments to the province, as well as policy support rendered to the company.

KEY RATING DRIVERS

Strategically Important to Yunnan: YEIG is Yunnan Province's sole energy platform. Hydropower is the key focus of energy development for the province, which ranks second among Chinese provinces in terms of hydro resources. YEIG holds certain power assets, especially hydropower assets, on behalf of the province. The company is also charged with developing the gas distribution network in Yunnan by the government.

YEIG's strategic role in ensuring energy security for the province is weaker compared with that of other rated province-owned power companies in China, such as Zhejiang Provincial Energy Group Company Ltd. (A/ Stable) and Beijing Energy Investment Holding Co., Ltd (A+/Stable). YEIG is important to Yunnan province mainly due to its generation of income and value from the province's hydro resources. The company is one of the largest in terms of assets and it generates the most profits among the companies owned by the Yunnan State-Owned Assets Supervision and Administration Commission (Yunnan SASAC).

Strong Linkage with Parent: YEIG is indirectly 97.18% owned and ultimately controlled by the Yunnan SASAC. The company has several immediate shareholders, all of which are Yunnan SASAC-owned companies, but YEIG is effectively managed and controlled directly by the Yunnan SASAC in terms of key strategies, investments, management appointments and financial management. Apart from initiating asset transfers into YEIG, the Yunnan Province also supports YEIG through subsidies and policy support.

Yunnan's Healthy Creditworthiness: Yunnan Province has a healthy budget underpinned by strong central government support via China's robust fiscal equalisation system, where less developed regions receive government transfers sourced from more developed areas. The strengths are partially mitigated by its moderate standalone fiscal strength before fiscal transfers from the central government, rapidly rising provincial government debt and relatively weak transparency.

Minority Ownership in Key Assets: YEIG holds its most important assets, the China Huaneng Group (CHNG) Lancang River Hydropower Project and Jinsha River Downstream Hydropower Project, through minority investment interests. Dividends from these projects account for a substantial portion of YEIG's funds flow from operations (FFO), and Fitch expects this to remain so in the foreseeable future. YEIG does not operate or have full control over these projects, though its interests are represented through proportionate board membership in the project companies. The company has 100% ownership in other power projects, but they are smaller in scale.

Evolving Business Profile: YEIG was established in 2012 through asset injections directed by the Yunnan SASAC. Apart from energy businesses, YEIG also invests in other ancillary businesses including trading and financial investments. YEIG's business profile may evolve, although Fitch expects the company to remain focused on the energy segment.

Weak Standalone Financial Profile: YEIG has been funding its investments through debt since its establishment, which has resulted in high leverage. However, it does not pay dividends. FFO net leverage was 9.7x in 2014, and at 16.1x if adjusted for equity earnings and dividend receipts. Fitch expects capex and cash injections to associates to continue to be high in 2016-2017, which would limit room for significant deleveraging even though cash flow will increase as generation capacity is gradually completed.

About two-thirds of YEIG's cash flow was historically generated from dividends. Fitch expects YEIG's cash flow to continue to rely heavily on dividend receipts, which are generally stable from the hydropower assets. The company's FFO fixed-charge coverage was 1.25x in 2014 and Fitch expects YEIG to maintain the coverage ratio at around 1.5x in the medium-term. YEIG's standalone credit profile is assessed at 'B'.

KEY ASSUMPTIONS

Fitch's key assumptions within our rating case for the issuer include:
- Revenue gradually increasing in 2016 and 2017 with completion of power generation facilities under construction, as well as expansion of the gas distribution business.
- Single-digit percentage growth in income and cash dividend receipts from YEIG's key associates in 2016-2017, in tandem with the completion of new hydropower generation capacity
- Capex plus injections to associates totalling CNY7bn-8bn in 2016 and tapering off from 2017, with gradual completion of expansion in CNGH Lancang River Hydropower Project and the company's new energy facilities that it will operate

RATING SENSITIVITIES

Negative rating action could follow a lowering of Fitch's internal assessment of the creditworthiness of the Yunnan Province, or upon evidence of a weakening of YEIG's legal, operational and strategic linkages with Yunnan Province.

Positive rating action is likely upon an upgrade of Fitch's internal assessment of the creditworthiness of the Yunnan Province, provided YEIG's linkages with the province remain intact.