China SOE Credits – One for Every Palate
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l Global Research l Credit Alert | 05:45 GMT 14 January 2013 China SOE credits – One for every palate We provide a framework for spread differentiation among Chinese SOEs The SOEs are attractive against Korean and Hong Kong credits; we recommend an Overweight position Our top picks are concentrated in the oil and gas names and the stronger triple-B space China has 117 centrally owned SOEs, and not all of them are created equal. Bharat Shettigar, +65 6596 8251 [email protected] The SOEs with USD bonds comprise an increasingly heterogeneous mix of credits. In this report, we outline a framework for differentiation among Jaiparan Khurana, +65 6596 7251 [email protected] credits based on ownership profile, strategic importance, government support, regulatory issues, financial risk, bond language and rating notching. While China‟s ability to support its SOEs is strong, its willingness to support all of its SOEs is unproven. Hence, it is very important to focus on each SOE‟s fundamental business and financial risk profile, apart from assessing the strength of its government linkage and potential support. EMBI index eligibility is also a key factor for spreads of certain credits. We assign limited importance to the difference in bond structure and language, at least among existing issuers. China‟s economic growth over the past few years has been driven by leverage, and SOEs have been at the forefront of this trend. Credit metrics for most of the USD bond issuers are currently weaker than in 2009-10. With organic capex and overseas acquisitions expected to remain high, we do not expect an improvement in the next 6-12 months. Low-triple-B credits are most at risk of rating downgrades and spread widening. Longer-term, potential SOE reforms could act as a negative for some credits, as they may lose their protected market positions and easy access to financing. The low USD yield environment, overseas acquisitions, diversification of funding channels and extension of debt maturity drove the huge issuance from SOEs in 2011 and 2012. However, domestic rate cuts in H2-2012 and the rapid development of the local corporate bond market may preclude Top picks some offshore issuance going forward. We expect c.USD 16.5-17.5bn of CNOOC 21 CNPCCH 41 issuance in 2013, broadly similar to the USD 17.15bn printed in 2012. CHRESO 17 SINOCH 40 China SOEs currently offer a 30-70bps pick-up over US credits on a ratings- CHINAM 22 adjusted basis. Also, the valuations of Chinese SOEs are marginally CHIOLI 20 attractive versus Korean and Hong Kong credits. We therefore recommend Top pans an Overweight position in the context of the Asian high-grade space. That CNOOC 42 said, significant spread tightening from here will be contingent on overall COSL 22 CRHZCH 16 market technicals remaining overwhelmingly positive. CHMETL 16 CITPAC 21/23 We recommend that investors stay invested in the highly rated oil and gas names and take some balance-sheet risk by investing in stronger triple-B credits like Sinochem, China Merchants and China Overseas Land. We are slightly concerned about names like China Metal, Yanzhou Coal and CITIC Pacific and recommend an opportunistic approach to these credits. Important disclosures can be found in the Disclosures Appendix All rights reserved. Standard Chartered Bank 2013 research.standardchartered.com Credit Alert Credit spread differentiation There has been a spate of offshore issuance by Chinese SOEs since late 2010, and the space now comprises an increasingly heterogeneous mix of companies. This is unlike other countries in Asia, where most quasi-sovereigns with USD bonds enjoy high strategic importance and an almost certain likelihood of government support. Hence, in China‟s case, it is equally important to focus on an SOE‟s fundamental business and financial risk profile as it is to assess the strength of its government linkage and potential support. We believe rating agencies have done a fairly good job of differentiating between the credits, rating them from as high as Aa3/AA- to as low as Ba1/BB+ (in other jurisdictions, most quasi-sovereigns are rated close to the sovereign). From our standpoint, there are five factors that determine spread differentiation in the space; the first three are the most critical. 1. Business risk profile: We assess business risk based on the perceived importance and prospects of the industry, the company‟s competitive position, operational risks and regulatory considerations. Typically, energy, utility and infrastructure companies score higher than companies in more competitive industries like commodities and property. 2. Financial risk and policies: To assess financial risk, we look at a number of ratios that measure the company‟s capital structure and cash-flow adequacy. Financial risk tolerance policies also play an important role; for instance, CR Gas‟ part-financing of its acquisition through equity issuance and CR Power‟s scaling-back of investments to protect its ratings are important considerations. 3. Strategic importance and support: China‟s SOEs have received preferential treatment in the form of capital injections, operational support and easier access to financing. However, in most cases, individual SOEs have not been established under a clear regulatory mandate. Some could undergo restructuring or see their protected market positions eroded over the medium to long term. In addition, China‟s willingness to support its SOEs (and their offshore creditors) is unproven. We also point out that close government linkages can act as a double-edged sword. For instance, while CITIC Pacific and China Metal are of „moderate‟ strategic importance (according to our definitions), they have been required to undertake large overseas projects, which have impacted their credit risk profiles. Finally, we do not differentiate much between SOEs owned by the central government and those owned by local governments. As a result, for credits like Shenzhen International and Yanzhou Coal, business and financial risk are bigger determinants of credit standing than their ownership. 4. Index eligibility: The Sinopec, Sinochem and China Metal bonds are guaranteed by entities that are 100% owned by the government. They are therefore the only Chinese SOEs included in the EMBI index, which acts as a positive technical. The Sinopec bonds quote tighter than CNOOC and CNPC, despite their lower ratings. That said, EMBI-focused investors may choose to ignore small bond issues from weaker entities like China Metal. 5. Bond structure: Since Chinese corporates have to undergo stringent regulatory approvals to issue offshore debt, some of them have created differentiated bond structures to make investors more comfortable. Among existing issuers, only Sinopec, China Oilfield, Yanzhou Coal and China Metal have their bonds guaranteed by onshore entities. Some bonds have a „keep-well agreement‟ or „letter of support‟, while the change-of-control language varies widely among the issuers. While these differences may eventually prove important for spread differentiation among lower-quality SOEs, we believe the first four factors mentioned above are far more important for the existing set of issuers. GR13JA | 14 January 2013 2 Credit Alert Figure 1: Summary credit profile Govt. Strategic Financial ownership importance profile Sinopec 100.0% High Moderate CNOOC 64.4% High Strong CNPC 100.0% High Strong China Oilfield 53.6% Moderate Moderate CR Gas 68.5% Moderate Moderate Beijing Enterprises 59.3% Moderate Moderate Sinochem 100.0% High Weak China Merchants Holdings 54.7% Moderate Moderate China Overseas Land 29.2% Moderate Moderate CR Power 63.6% Moderate Moderate CR Land 68.0% Low Moderate Shenzhen International 48.6% Moderate Moderate Yanzhou Coal 52.9% Moderate Moderate China Metal 100.0% Moderate Weak Franshion 62.9% Low Moderate CITIC Pacific 57.6% Moderate Weak Sources: Companies, Standard Chartered Research Figure 1 summarises the overall credit standing of China‟s SOEs with USD bonds outstanding. In Figures 5-12, we provide a detailed comparison of these entities based on factors such as rating notching, ownership profile, strategic importance, government support, regulatory issues, financial risk profile and bond language. Based on these comparisons, we accord fair-value spread multiples for the various entities, as shown in Figure 2 below. We start with Sinopec and work our way down the credit spectrum. Figure 2 indicates a company‟s fair Z-spread multiple versus the companies placed immediately above it. For instance, we believe Sinochem‟s Z-spreads should be 1.10-1.25 times those of China Oilfield, CR Gas or Beijing Enterprises on a duration-adjusted basis, while Shenzhen International‟s spreads should be 1.1-1.3 times CR Land‟s. As we move towards the lower rung of credits in the crossover/high-yield category, it gets more difficult to assess fair spreads; we therefore assign a wider range for the multiple. Also, our assessment of these credits could change over the next few months depending on movements in their credit fundamentals and ratings. We also show spread multiples for CR Cement and China COSCO. While we do not formally cover these companies, these multiples pertain to their credit-enhanced bonds (through DBS Bank‟s Hong Kong branch and Bank of China‟s Beijing branch, respectively) and are not based on their standalone credit fundamentals. Figure 2: Fair spread multiples in the 5-10Y maturity bucket Credit-enhanced Senior bonds Multiple Multiple bonds Sinopec 1.00 CNOOC/CNPC 1.05-1.15 China Oilfield/CR Gas/Beijing Enterprises 1.15-1.30 CR Cement 1.15-1.30 Sinochem 1.10-1.25 China COSCO 1.10-1.25 China Merchants/China Overseas 1.05-1.25 Land/CR Power CR Land 1.05-1.15 Shenzhen International 1.10-1.30 Yanzhou Coal 1.10-1.25 China Metal/Franshion 1.15-1.40 CITIC Pacific 1.10-1.25 Note: The numbers indicate the fair spread multiple for a company versus the companies placed immediately above it.