Moody's Investors Service has assigned an A1 issuer rating to China Three Gorges Corporation ("CTG").
The outlook for the ratings is stable.
This is the first time Moody's has assigned a rating to CTG.
CTG's A1 rating reflects its baseline credit assessment ("BCA") of 10, equivalent to a Baa3 level on Moody's global rating scale, and a five-notch uplift after consideration of expected very high support from the Chinese government (Aa3, positive), under Moody's joint default analysis approach for government-related issuers.
This expectation of very high support is based on: 1) CTG's 100%-government ownership; 2) its strategic importance to China's social and economic development, including the development of clean energy; and 3) the government's strong history of support.
"CTG is the owner and operator of the Three Gorges Project ("TGP"), the world's largest hydroelectricity project. The TGP is one of the highest profile initiatives of the Chinese administration and, as such, its failure would imply high reputation risk to the government," says Ivan Chung, a Moody's Vice President and Senior Analyst, and CTG's international lead analyst.
"The presence of a support letter from China's Ministry of Finance formalizes the government's recognition of CTG's importance", says Chung. The letter indicates that the government will support CTG to the extent permitted by national policy when necessary and will take steps to ensure CTG maintains a healthy financial profile.
CTG's BCA of 10 is underpinned by its dominant position in China's hydropower industry, possession of large-scale low-cost generation assets, stable cash flow, as well as its good access to the capital markets and banking credit.
"Furthermore, CTG will benefit from China's fast growing economy and strong demand for power", says Kai Hu, Moody's local market analyst for CTG. "The clean nature of hydropower makes CTG a core element of the government's goal of supporting renewable energy."
Under the country's current regulatory framework, CTG's on-grid tariffs -- which are approved based on a "cost plus reasonable profit" principle and benchmarked to the average on-grid tariffs in the power consumption regions -- mean higher profitability.
Although its existing on-grid tariffs are 30-40% lower than the national average, its cost base -- when compared to those of its thermal power sector peers -- is lower and it has minimal exposure to fuel price risk. Regulations also stipulate that the grids dispatch hydroelectricity output on a priority basis, ensuring high utilization.
Despite these advantages, hydropower is not without risks in China. Social and environmental challenges could give rise to material contingent liabilities for CTG and/or result in a shorter-than-expected economic life for TPG.
At the same time, the extent of its financial responsibility for these matters has been defined by the current policy framework, providing a degree of predictability. Moody's also notes the government's active response to these problems in recent years.
The government has authorized CTG to develop four cascade hydropower stations downstream of the Jinsha River, which will double total installed capacity in operation owned by CTG. Upon completion, CTG will become the world's largest hydropower company. Moody's expects CTG's possession of the premium hydropower resources will provide it with a stable source of cash flow.
CTG's ambitions to become a global player and its domestic projects demand a large amount of capital spending. Assuming the absence of extra equity financing, FFO/debt will be stressed to around 10% in the next few years and debt/capitalization will reach 45% in 2013-2014. However, such situation will be improved when CTG's other two large hydropower stations (Xiang jiaba station and Xi luodu station) begin to operate within one or two years. Nonetheless, such credit metrics would still be commensurate with its current standalone Baa3 rating because of its low leverage.
CTG has a sound liquidity profile, supported by its Rmb 13.7bn cash holdings, Rmb 12.6 bn in available-for-sale financial assets, and Rmb 19.6bn in cash flow from operations during 2011, as well as its easy access to the domestic bond market and bank credits.
Meanwhile, CTG's standalone credit is constrained by the high geographic concentration of its generation assets and the relatively short operation record of TGP. The standalone Baa3 rating also reflects its holding company status.
The rating outlook is stable, reflecting Moody's expectation that: 1) CTG will execute project development according to its plan; 2) the policy and regulatory environment will remain stable; and 3) associated social and environment problems will not deteriorate suddenly.
Upward rating pressure is limited in the near term as CTG will continue to generate negative free cash flow and will raise leverage in the near to medium term.
Its standalone rating would be lowered if CTG: 1) incurs material cost overruns or delays in its major projects; 2) is unable to obtain sufficient external funding to support capex or refinance maturing debt; 3) social and environmental problems lead to unexpected significant liabilities; or 4) changes in government policy erode profitability and cash flow.
The credit metrics that Moody's would consider for a downgrade include: Adjusted debt/capitalization above 50% and/or (CFO pre-WC)/debt below 10%.
The principal methodology used in rating CTG was the Global Regulated Electricity and Gas Utilities Methodology published in August 2009 and Government-Related Issuers: Methodology Update published in July 2010.