Zhaojin Mining Industry Co. Ltd. And Its Guaranteed Notes Assigned 'BB+' Rating; Outlook Stable

 18-Oct-2018 22:16 EDT

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 We view as a core subsidiary of Zhaojin Group, which has a similar credit profile. We expect the group to extend timely support to Zhaojin Mining if needed.  Zhaojin Mining has high dependence on , limited geographical diversity, and high leverage. The company's long mine life, strong growth prospects, and low production costs support its stand-alone creditworthiness.  We are assigning our 'BB+' long-term issuer credit rating to Zhaojin Mining and our 'BB+' long-term issue rating to the notes that the -based gold producer guarantees.  The stable outlook reflects our view that Zhaojin Mining and Zhaojin Group can withstand a moderate decline in gold prices if industry conditions deteriorate over the next 12 months.

HONG KONG (S&P Global Ratings) Oct. 19, 2018--S&P Global Ratings today assigned its 'BB+' long-term issuer credit rating to Zhaojin Mining Industry Co. Ltd. (Zhaojin Mining). The outlook is stable. Zhaojin Mining is a gold miner based in China's Shandong province.

We also assigned our 'BB+' long-term issue rating to the company's proposed guaranteed senior unsecured notes. Zhaojin Mining International Finance Ltd., a wholly owned subsidiary of Zhaojin Mining, will issue the notes.

The rating on Zhaojin Mining reflects our expectation that the company will remain a core subsidiary of Shandong Zhaojin Group Co. Ltd. (Zhaojin Group). We believe Zhaojin Mining will receive timely and sufficient support from Zhaojin Group if needed. We therefore equalize the rating on the company with the credit profile of Zhaojin Group.

We anticipate that Zhaojin Group will maintain its majority shareholding in Zhaojin Mining. In our view, Zhaojin Mining will remain integral to the overall development strategy of the group, being the latter's only gold mining subsidiary. Zhaojin Group's other businesses, including downstream gold fabrication, processing, and retail, further integrate Zhaojin Mining into the group. We also expect Zhaojin Mining to remain the major profit contributor for the group over the next few years. The group's other businesses generate much smaller profit than the mining business due to low margins. As a result, we believe that Zhaojin Group has similar business strengths as those of Zhaojin Mining.

We believe Zhaojin Mining will maintain its single commodity focus, exposing it to the cyclical fluctuations in gold prices. We also expect the company to remain less geographically diversified as compared with some of its peers. We anticipate that Zhaojin Mining's operations will continue to be concentrated in China over the next one to two years, given that the company is cautious in investing overseas. Specifically, around 55% of its mined gold production will continue to come from Shandong province.

At the same time, we believe that Zhaojin Mining will maintain its competitive advantages of sufficient mine reserves, high volume growth, and low production costs over the next one to two years. The company has a mine life of 29 years, providing visibility for long-term production. It also has strong organic growth prospects. Its Haiyu mine is set to commence production in 2020 and will lift the company's mined gold production significantly. Zhaojin Mining's unit cash cost of Chinese (RMB) 107 per gram (or roughly US$494/ounce) for mined gold placed it in the first quartile of the global cost curve in 2017. Its cost advantage mainly derives from its high ore grade, good geological conditions, and advanced technology, which helps it to improve the metal recovery rate.

In our view, Zhaojin Mining's leverage will remain high and edge up in 2018-2019. We forecast that the company will generate steady operating cash flows in 2018-2019, based on our assumptions of stable sales volume and gold prices. However, we expect sizable capital expenditures over the period, mainly for mining capacity expansion. This will keep Zhaojin Mining's debt high and constrain its financial strength. We expect meaningful deleveraging in 2020 when the Haiyu mine kicks off.

We believe Zhaojin Group's leverage will move in tandem with that of Zhaojin Mining. The group has higher leverage as compared with Zhaojin Mining due to its higher capital spending and therefore elevated debt. We believe that deleveraging will happen in 2020 with incremental profit contribution from the Haiyu mine. Other measures including mixed ownership reform should also support deleveraging, but we haven't factored these in our base case, given the uncertainty. Meanwhile, we expect the group to maintain EBITDA interest coverage above 2.0x, adequate liquidity, and solid banking relationships over the next 12-24 months.

We assigned a positive comparable rating analysis to Zhaojin Mining. This is because the company receives ongoing support including government subsidies and also support in securing good quality gold mines in Shandong province. Moreover, we view the group to have an integrated business model and exposure to the full value chain of the gold industry with large downstream operations. The above gives Zhaojin Mining a better competitive advantage than peers.

Zhaojin Group is a state-owned enterprise (SOE) that the Zhaoyuan municipal government controls. Zhaoyuan is a county-level city under the jurisdiction of Yantai city in Shandong province. In our view, Zhaoyuan's economy benefits from its rich gold endowment, which has led to GDP per capita of more than twice the national average. Zhaoyuan has a moderate debt burden and high contingent liabilities. Mitigating these risks are the city's high operating balance and exceptional liquidity that can fully cover its next 12 months' principal and interest payments. We expect the city to maintain a modest budget deficit, given the government's record of financial management.

In our view, Zhaojin Group has a very high likelihood of receiving extraordinary support from the Zhaoyuan government in case of financial distress. This view is based on the following company characteristics:

 Very strong link with the government. Zhaoyuan government owns 100% of Zhaojin Group. We believe that the government will not contemplate privatization in the next two to three years at least. Zhaoyuan State-owned Assets Supervision and Administration Commission appoints Zhaojin Group's board members and senior management. In our view, the local government has strong influence on the company's strategy and business plans, and it has processes in place to continuously monitor the company. We believe that a considerable deterioration in the creditworthiness of Zhaojin Group would significantly affect the reputation of the Zhaoyuan government. It may also hurt the ability of other government-related entities that are controlled by the local government to access debt capital markets.  Very important role to the government. The gold sector is a pillar industry in Zhaoyuan and one of the most important industries in Shandong province. Zhaojin Group is the largest gold producer in Zhaoyuan, the second-largest in Shandong, and the fourth-largest in China. It's also designated by the local government to be the consolidator of the gold industry. We believe credit stress or a default by the company would not only have an important impact on the local gold sector, but also a systemic impact on the local economy.

The stable outlook reflects our view that Zhaojin Mining and Zhaojin Group can withstand a moderate decline in gold prices over the next 12 months if industry conditions were to deteriorate. We also anticipate that Zhaojin Mining will remain a core subsidiary of Zhaojin Group, and that the parent will have a very high likelihood of receiving extraordinary government support in case of financial distress.

We could lower the rating on Zhaojin Mining if Zhaojin Group's EBITDA interest coverage falls below 2.0x for a sustained period. This may happen if: (1) gold prices are 15%-20% below our expectation; or (2) the company sees significant overruns in its production costs or capital spending, or prolonged delays in commencement of the Haiyu mine.

We could also downgrade Zhaojin Mining if the credit strength of the Zhaoyuan government deteriorates.

We may upgrade Zhaojin Mining if Zhaojin Group's financial metrics improve meaningfully for a sustained period. An indication of such improvement would be Zhaojin Group's debt-to-EBITDA ratio falling below 4.0x. This could happen if the company's cash flow improves on higher gold prices or lower capital spending. We see limited upside potential in the near term.

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