OREANDA-NEWS. Fitch Ratings has assigned China Southern Power Grid Co., Ltd (CSG) a Long-Term Foreign-Currency Issuer Default Rating (IDR) of 'A+'. The Outlook is Stable. Fitch has also assigned CSG a senior unsecured rating of 'A+'.

Simultaneously, Fitch has assigned China Southern Power Grid International (Hong Kong) Co., Ltd. (CSGI HK) a Long-Term Foreign-Currency IDR of 'A'. The Outlook is Stable. Fitch has also assigned CSGI HK a senior unsecured rating of 'A'.

The ratings of CSG are equalised with that of China (A+/Stable), the company's effective parent, as per Fitch's Parent and Subsidiary Linkage methodology. The equalisation of CSG's ratings with the sovereign takes into consideration its strategic importance to China, as well as the strong operational and financial support the government consistently provides to CSG.

CSGI HK is rated one notch down from its 100% owner, CSG, based on the top-down approach as per Fitch's Parent and Subsidiary Linkage methodology. This approach reflects the strong legal as well as operational linkages between the two entities; the significant tangible support CSG has extended to CSGI HK, including the provision of guarantees and keep-well deed support for a significant portion of CSGI HK's debt.

KEY RATING DRIVERS

Strategic Role in China: CSG is one of China's two nationwide power transmission and distribution companies. CSG is the monopoly power grid operator in the southern five provinces of China of Guangdong, Guangxi, Yunnan, Guizhou and Hainan covering around 230 million residents. CSG is also a major electricity supplier to both Hong Kong and Macau. With its strategic position in China's energy value chain, CSG is considered crucial in China's national strategy to promote clean energy and balance geographical energy demand-supply imbalances.

Support from Government: CSG has been consistently receiving financial support from the central government, including sizeable capital injections, operating subsidies and tax benefits. CSG is also allowed to retain all its earnings for its development activities. Most importantly, the regulatory environment has been highly beneficial to the two national power grid operators. CSG has enjoyed a rather stable transmission tariff, while the on-grid and retail tariffs have fluctuated.

Strong State Control: CSG has four shareholders, including the China central government (26.4%), Guangdong province (38.4%), Hainan province (3.2%) and China Life Insurance (Group) Company (32%). The central government retains very strong control over CSG's operations and strategies even though it does not have majority control of CSG. The central government has increased its stake in CSG in the past and is likely to continue to increase its control in future.

Evolving Regulatory Environment: China is trying a new power transmission tariff scheme in several regions, including Shenzhen city, Yunnan province and Guizhou province, which are under CSG's coverage. The new mechanism aims to separate the transmission tariff from the on-grid and retail electricity tariffs clearly, and link it to the grid operator's asset base and a reasonable return on capital employed. The precise financial impact on grid operators remains uncertain, with the new scheme in effect for less than one year. Although we expect overall returns to narrow for the two grid operators under this scheme, Fitch believes the new scheme provides a greater level of stability and transparency to their earnings.

Solid Standalone Profile: CSG's business and financial metrics are robust for its 'A' standalone credit profile. Fitch expects CSG's cash flow generation to remain strong, funds flow from operations (FFO)-adjusted net leverage to remain below 3x (end-2014: 2.9x) and FFO fixed-charge coverage to be around 6x (end-2014: 5.7x) in the next three to four years. CSG also maintains healthy liquidity and a well-diversified debt maturity profile.

CSGI HK's Linkage to CSG: CSGI HK is CSG's fully owned major overseas investment subsidiary. CSGI HK's current investments include a 30% share in Castle Peak Power Company Limited, which is Hong Kong's largest independent power producer, and 0.61% of the listed shares in CGN Power Company Limited - China General Nuclear Power Corporation's (A+/Stable) major nuclear-power operating subsidiary.

The significant tangible support CSG has provided to CSGI HK is the major driver of the close rating linkages between the two entities. CSG has provided guarantee and keep-well deed support for a significant portion of CSGI HK's debts. CSG is also committed to continuing to provide financial support for CSGI HK's future investments. In addition, operational overlap between CSGI HK and CSG is robust, as the parent has very strong control over CSGI HK's management and investment strategies.

KEY ASSUMPTIONS

Fitch's key assumptions within the rating case for the issuer include:
- CSG's power sales to grow by 3% a year for industrial users and 7%-9% a year for non-industrial users
- Gap between retail tariff and on-grid tariff to remain generally stable
- Total capex in the range of CNY70bn to CNY83bn in the next three to four years

RATING SENSITIVITIES

CSG:
Future developments that may, individually or collectively, lead to negative rating action include:
- A negative rating action on the China sovereign;
- A significant weakening of linkages with the sovereign in conjunction with a material deterioration in the standalone credit profile of the company;
- CSG's 'A' standalone profile may be lowered if its FFO-adjusted net leverage deteriorates to over 3.0x and/or its FFO interest cover falls to less than 5.0x, on a sustained basis.

Future developments that may, individually or collectively, lead to positive rating action include:
- A positive rating action on the China sovereign provided CSG's linkages with the sovereign remain intact.

CSGI HK:
Future developments that may, individually or collectively, lead to positive rating action include:
- A positive rating action on CSG provided CSGI HK's linkages with CSG remain intact.

Future developments that may, individually or collectively, lead to negative rating action include:
- A negative rating action on CSG or weakening of CSGI HK's linkages with CSG, such as a material reduction of control, or materially weaker than historical support extended to CSGI HK by CSG

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

The main factors that individually, or collectively, could trigger positive rating action on China include:
- 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

The main factors that individually, or collectively, could trigger negative rating action on China include:
- 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