OREANDA-NEWS. Fitch Ratings has affirmed the ratings on Hong Kong-based CLP Holdings Limited (CLPH) and its wholly owned subsidiary, CLP Power Hong Kong Limited (CLP HK). The Long-Term Foreign - and Local-Currency Issuer Default Ratings (IDRs) of the two entities are affirmed at 'A' and Short-Term IDRs at 'F1'. The Outlook on the Long-Term IDRs is Stable.

KEY RATING DRIVERS

Stable, Regulated Cash Flow: The ratings of CLPH reflect the predictable cash flow from CLP HK, which typically contributes around 60%-70% of CLPH's total EBITDA. CLP HK benefits from a monopoly, vertically integrated electricity business in Kowloon and the New Territories, which is regulated under the transparent and supportive framework, the Scheme of Control (SoC). The SoC allows CLP HK a permitted rate of return and operating cost pass-through, including full fuel cost pass-through, which contributes to CLP HK's stable operating margin.

Regulatory Uncertainty in Hong Kong: The current, favourable 10-year regulatory period ends in 2018. The current SoC allows for an annual return of 9.99% on CLP HK's net fixed assets, excluding renewable energy investments, which earn an 11% annual return. The terms for the next 10-year regulatory period are currently being negotiated among the regulator (the Hong Kong government), CLP HK and the other regulated utility, Hong Kong Electric Company. We expect further clarity on the outcome over the next few months. CLP now maintains relatively generous headroom under its ratings, especially with the stabilisation of its operations in key overseas markets. However, this cushion could be eroded if regulatory changes result in significantly reduced returns for its Hong Kong operations, especially considering the increasing operating and capital costs likely with the tighter environmental standards targets in the city.

Environmental Legislation Uncertainty: Potential cost pressures from environmental legislation in Hong Kong and Australia, including the long-term availability of alternative fuel supplies on competitive terms, are among the challenges for the company, given its substantial portion of coal-fired generation.

CLP HK has had to modify its generation fleet - including switching existing coal-fired plants to gas-fired generation - due to tighter emissions targets set by the Hong Kong government. We expect CLP HK to make additional investments in gas-fired generation, likely from 2017, to meet the Hong Kong government's proposed 2020 fuel-mix targets (50% gas, 25% nuclear and 25% renewables and coal), as its generation is currently 25% gas, 32% nuclear and 42% coal. We have assumed continued full and timely recovery of fuel costs, and additional, but moderate capex, spread over three years and commencing in 2017, in our base-case scenario. However, further clarity on this is only expected once terms of the next SoC are finalised.

Elevated Capex, Stable Financial Profile: We expect CLPH's capex to remain elevated due to the investment requirements of CLP HK, while growth capex for its international business will remain moderate. Nevertheless, the company's robust operational cash flow, supported by the regulated Hong Kong business, will contribute to a stable financial profile, assuming no material step-up in the company's dividend policy and no material debt-funded acquisitions. We have assumed a challenging, but stable operating environment for EnergyAustralia, a leading integrated utility, in our base case.

International Diversification, Some Volatility: CLPH's international business includes EnergyAustralia, which typically accounts for 15%-20% of CLPH's total EBITDA annually, and generation assets in China, India and south-east Asia. These provide geographic diversification, but are of higher business risk compared to its HK operations as they are either largely unregulated or only quasi-regulated, contributing to some earnings and cash flow volatility for the group. Operating conditions in India (6% of reported 2015 EBITDA) have improved, and we expect the company to further invest in the power sector there. In China (9% of reported 2015 EBITDA) we expect CLPH to face some margin pressure in coal-fired generation (nearly half its China portfolio by capacity) as power over-capacity further worsens and increased coal prices put pressure on dark spreads.

CLP HK's Ratings Constrained: Fitch analyses CLPH and CLP HK as a consolidated entity due to their strong linkages, reflecting the integration of CLP HK within the group, but this approach constrains the latter's ratings.

KEY ASSUMPTIONS

Fitch's key assumptions within the rating for CLPH include:

- Modest revenue and EBITDA growth in 2016-2017

- Continued elevated capex with capex/revenue of around 14%-15% in 2016-2017 (2015: 14.2%)

- No acquisitions

- Moderate dividends in 2016-17

RATING SENSITIVITIES

Negative: Future developments that may, individually or collectively, lead to negative rating action include:

- Adverse regulatory changes, especially a significant reduction in the regulatory return of CLP HK

- Substantial increase in business risk, through investments in non-regulated business

- FFO adjusted net leverage above 3.5x on a sustained basis (2015: 2.6x)

- FFO interest cover below 5.0x on a sustained basis (2015: 5.4x)

Positive: Fitch does not anticipate events, individually or collectively, leading to a rating upgrade in the medium term.

FULL LIST OF RATING ACTIONS

CLP Holdings Limited

--Long-Term Foreign-Currency IDR affirmed at 'A'; Stable Outlook

--Long-Term Local-Currency IDR affirmed at 'A'; Stable Outlook

--Short-Term IDR affirmed at 'F1'

CLP Power Hong Kong Limited

--Long-Term Foreign-Currency IDR affirmed at 'A'; Stable Outlook

--Long-Term Local-Currency IDR affirmed at 'A'; Stable Outlook

--Short-Term IDR affirmed at 'F1'