Fitch Upgrades China Oriental to 'BB'; Outlook Stable

China Oriental

24/09/2018 07:36

(The following statement was released by the rating agency)


Fitch Ratings-Hong Kong/Shanghai-September 24: Fitch Ratings has upgraded China 
Oriental Group Company Limited's (COG) Long-Term Foreign-Currency Issuer Default 
Rating (IDR) and senior unsecured rating to 'BB' from 'BB-'. The Outlook is 
Stable. 

The upgrade reflects a significant improvement in COG's financial profile, 
driven by strong free cash flow generation from its core steelmaking business, 
which we expect to continue with support from a favourable domestic operating 
environment and COG's prudent financial policies. The ratings are constrained by 
COG's concentration in China's Hebei province, which is a focal point for 
policymakers in terms of capacity shutdown and production curtailment. We 
believe this increases the likelihood of policy-driven disruption to COG's 
steelmaking business and higher spending on environmental-related equipment and 
upgrades.

KEY RATING DRIVERS

Improved Profitability: COG's steel gross profit per tonne increased to CNY675 
per tonne in 1H18, from CNY233 per tonne in 2016. Steel prices have continued to 
rise, but prices of raw material such as iron ore and coking have remained 
stable, allowing Chinese steelmakers to enjoy elevated profitability for the 
past 18 months. We expect COG's gross profit per tonne profitability to remain 
at around CNY660 in 2018 and CNY520-580 per tonne over 2019 and 2020, supported 
by stable steel prices and Fitch's lower iron ore and coking coal forecasts.

High Net Cash: COG had net cash of CNY3.3 billion in 2017 and CNY4.0 billion in 
1H18, a turnaround from its net debt position of CNY971 million in 2016, driven 
by strong cash flow generation from its core steelmaking business. The company 
has a solid record of generating strong free cash flow, even during the severe 
sector downturn in 2015. We expect this to continue with support from robust 
steelmaking profitability, despite increased capex on environmental upgrades and 
higher dividend pay-outs. COG should maintain its net cash position provided 
there are no major M&A or investments in the near term. 

Rising Capex: We expect capex to increase to around CNY2.0 billion in 2018 and 
CNY1.5 billion-2.0 billion each year in 2019 and 2020, from CNY0.5 billion in 
2017, to upgrade facilities to be compliant with the latest environmental 
standards and to upgrade existing blast furnaces. The capex will be funded by 
internal cash flow and we expect COG to remain free cash flow positive even 
after the increased capex. 

Substantial Foreign-Exchange Debt: Around 40% of COG's total debt is denominated 
in US dollars, while the majority of its revenue is in Chinese yuan. This 
creates a potential foreign-exchange mismatch and increases foreign-exchange 
risk should exchange-rate volatility increase. However, we believe the risk is 
low as COG is in a net cash position and employs currency hedging.

Relationship with ArcelorMittal: ArcelorMittal S.A. (BBB-/Stable) became COG's 
largest shareholder with a 37% share after management sold down shares to resume 
its listing in 2017. We believe the disputes regarding stake holding and 
insufficient public float issue between ArcelorMittal and COG's management have 
been temporarily resolved, but that if the relationship between the two parties 
further deteriorates, it could negatively affect COG's operations. ArcelorMittal 
has one seat on COG's board, which consists of nine directors. 

DERIVATION SUMMARY

COG has a smaller size and slightly lower profitability than Indian steelmakers, 
JSW Steel Limited (JSWS, BB/Stable) and Tata Steel Limited (TSL, BB/Rating Watch 
Evolving, standalone: BB-), as the Indian steelmakers have lower input and 
production costs as well as iron ore self-sufficiency. COG's financial are 
stronger than those of JSWS and TSL, as reflected in its strong net cash 
position, whereas JSWS and TSL have net leverage of around 4.0x-5.0x. COG's 
financial metrics are overall much better than those of 'BB' and 'B' rated peers 
and comparable with some investment-grade steel producers.

KEY ASSUMPTIONS

 Fitch's Key Assumptions within Our Rating Case for the Issuer

-    Capex of CNY2 billion per year between 2018 and 2020.

-    Dividend pay-out of 40% per year between 2018 and 2020.

-    Fitch iron ore price forecast of USD60 per tonne in 2018 and USD55 per 
tonne in 2019 and 2020.

-    Fitch hard coking coal price forecast of AUD185 per tonne in 2018 and 
AUD140 per tonne in 2019 and 2020.

RATING SENSITIVITIES

Developments that May, Individually or Collectively, Lead to Positive Rating 
Action

- Positive rating action is unlikely in the near term unless COG improves its 
operational diversification outside of Northern China 

Developments that May, Individually or Collectively, Lead to Negative Rating 
Action

-  FFO net leverage above 1.5x on a sustained basis

LIQUIDITY

Adequate Liquidity: COG has around CNY5.6 billion in cash and cash equivalents 
and around CNY1.7 billion in total debt at end-1H18. It also has CNY5.0 billion 
in unutilised banking facilities.   

Contact: 

Primary Analyst

Alan Jiang

Associate Director

+852 2263 9989

Fitch (Hong Kong) Limited

19/F Man Yee Building

68 Des Voeux Road Central, Hong Kong

Secondary Analyst

Charles Li

Associate Director

+86 21 6898 7990

Committee Chairperson

Laura Zhai

Senior Director

+852 2263 9974

For regulatory purposes in various jurisdictions, the supervisory analyst named 
above is deemed to be the primary analyst for this issuer; the principal analyst 
is deemed to be the secondary.

Media Relations: Wai-Lun Wan, Hong Kong, Tel: +852 2263 9935, Email: 
wailun.wan@fitchratings.com.

Additional information is available on www.fitchratings.com

Applicable Criteria 

Corporate Rating Criteria (pub. 23 Mar 2018)

https://www.fitchratings.com/site/re/10023785

Corporates Notching and Recovery Ratings Criteria (pub. 23 Mar 2018)

https://www.fitchratings.com/site/re/10024585

Sector Navigators (pub. 23 Mar 2018)

https://www.fitchratings.com/site/re/10023790

Additional Disclosures 

Dodd-Frank Rating Information Disclosure Form 

https://www.fitchratings.com/site/dodd-frank-disclosure/10045544

Solicitation Status 

https://www.fitchratings.com/site/pr/10045544#solicitation

Endorsement Policy 

https://www.fitchratings.com/regulatory

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