OREANDA-NEWS. Fitch Ratings has upgraded China Railway Group Limited's (CRG) Long-Term Issuer Default Rating (IDR) and senior unsecured rating to 'A-' from 'BBB+'. The Outlook on the IDR is Stable. Fitch has also upgraded the senior unsecured notes issued by CRG's subsidiary, China Railway Resources Huitung Limited, to 'A-' from 'BBB+'.

The upgrade reflects Fitch's upward reassessment of CRG's strategic importance to the Chinese sovereign (A+/Stable). Fitch believes competition in the Chinese railway construction industry is low, even though there are two major state-owned companies in this space. In addition, the strategic importance and scale of railway construction in China will likely remain high for many years, as there is a high need for the construction of urban railways throughout China.

CRG's strategic importance to the sovereign is similar to some other large infrastructure construction companies that operate in sub-segments with only one dominant player, for instance, China Communications Construction Company Limited (A-/Stable) in maritime construction and Power Construction Corporation of China (A-/Stable) in clean energy construction. All three entities are rated two notches below the sovereign using the top-down approach detailed in Fitch's Parent Subsidiary Linkage criteria and reflects their similarly strong importance to the sovereign.

KEY RATING DRIVERS

Secure Market Position: Fitch believes the government-granted duopoly market structure in railway construction will continue supporting CRG's leading market position. Although two players, CRG and China Railway Construction Corporation (CRCC), split market share almost evenly, the government strictly monitors the segment, from budgeting, ordering and quality to licenses, creating a high entry barrier for other players. The relationship between CRCC and CRG appears complementary rather than competitive, as the scale of the railway construction market is too big to be fulfilled by a single player.

Dominates Urban Rail Construction: CRG has the largest market share (50%-60%) of China urban rail construction, thanks to its technical strengths in design and tunnelling. The contribution of urban rail construction to CRG's new contracts increased to 14% in 2014 from 6% in 2010. Urban rail provides a key solution to growing traffic problems in China's burgeoning cities and will continue expanding rapidly, even though its length is currently only 3% of China's railway. According to government plans, urban rail mileage CAGR will be 16% for 2016-2020, compared to 3% for railway.

Supports China National Policy: Railway construction plays an important role in China's geopolitical relationships. CRG is frequently used in China's foreign policy. CRG has taken the majority of the railway project construction design and research in "One Belt One Road", a national strategy initiated by the government.

High Ownership and Control: CRG is 53.67% owned by China Railway Engineering Corporation (CREC) and accounts for almost all its assets and revenue. CREC is 100% owned by the State-owned Assets Supervision and Administration Commission. The government controls the board and makes all senior executive appointments.

Performs in Weak Market: In 2015, CRG maintained its EBITDA margin of 4.7%, despite a revenue slowdown caused by weakness in non-core business( such as property and mining). This weakness leads Fitch to expect 2% revenue growth in 2016, with EBITDA margin maintained at 4.5%-4.7%. CRG also maintained a 3x contract to revenue ratio in 2015. New contract growth for infrastructure construction has picked up following robust 15% growth in railway construction during 2015 and 2014.

KEY ASSUMPTIONS

Fitch's key assumptions within the rating case for the issuer include:
- new contract and revenue growth remaining stable in 2016-2018
- steady EBITDA margin for the construction operation
- annual capex of around CNY10bn in 2016-2018

RATING SENSITIVITIES

Positive: Future developments that may, individually or collectively, lead to positive rating action include:
- positive rating action on the Chinese sovereign
- strengthening linkages between CRG and CREC
- strengthening linkages between CREC and the Chinese sovereign

Negative: Future developments that may, individually or collectively, lead to negative rating action include:
- negative rating action on the Chinese sovereign
- weakening linkages between CRG and CREC
- weakening linkages between CREC and the Chinese sovereign

For the sovereign rating of China, the following sensitivities were outlined by Fitch in its Rating Action Commentary of 26 November 2015:

Positive
- Increased evidence that the economy can adjust smoothly while rebalancing without experiencing a disruptive "hard landing"
- Greater confidence that the debt problem in the broader economy can be resolved without a material negative impact on growth or financial stability
- Widespread adoption of the renminbi as a reserve currency globally

Negative
- A sharper growth slowdown than currently anticipated, leading to a materialisation of risks to financial and/or social stability
- A rise in estimated general government indebtedness well above Fitch's current estimate
- Sustained capital outflows sufficient to erode China's external balance-sheet strengths, or undermine financial stability
- A change in policy direction that signalled decreased willingness to tackle the economy's imbalances and vulnerabilities, thereby increasing the risk of an eventual disorderly adjustment

FULL LIST OF RATING ACTIONS

China Railway Group Limited
- Long-Term Foreign-Currency IDR upgraded to 'A-' from 'BBB+'; Outlook Stable
- Foreign currency senior unsecured rating upgraded to 'A-' from 'BBB+'.

Issuance by China Railway Resources Huitung Limited and guaranteed by CRG
- USD500m 3.85% notes due February 2023 upgraded to 'A-' from 'BBB+'.