Corporate China Pengyuan International Assigns ‘A-’ Rating to Shougang Group Co., Ltd.; Outlook Stable Ratings Overview Issuer Rating ▪ Pengyuan International has assigned its first-time global scale long-term LT Issuer Credit Rating A- issuer credit rating (LTICR) of ‘A-’ to Shougang Group Co., Ltd. (Shougang). The outlook is stable. Outlook Stable ▪ Shougang is the sixth largest steel producer in China and the tenth largest steel producer in the world, measured by crude steel production. Shougang’s issuer credit rating is based on a ‘b+’ standalone credit profile and our assessment that the Beijing government will provide strong support for the Contents Company in the event of a financial distress. Shougang takes the leading role as a diversified public-service provider in accordance with the coordinated development strategy of Beijing-Tianjin-Hebei (Jingjinji), the biggest Key Rating Drivers ........................ 2 urbanised megalopolis region in North China with strong backing from the Business Profile ............................ 3 Beijing government. The rating of the Company is constrained by its high leverage due to ongoing capex needs. Financial Profile ............................ 5 Government Support .................... 6 Rating Outlook Liquidity......................................... 7 ▪ The stable outlook reflects our view that the Company’s operations will remain Company Background .................. 7 stable amid the recovery of China’s economy. The stable outlook on Peer comparison ........................... 7 Shougang also reflects a similar outlook on the Beijing government and our expectations that the Beijing government’s willingness to support the Rating Scores Summary ............... 9 Company in the event of financial distress remains unchanged. Related Criteria ............................. 9 ▪ We would consider a rating downgrade if 1) substantial evidence shows that the Beijing government’s willingness to support the Company weakens; 2) we downgrade our credit rating of the Beijing government. ▪ We would consider a rating upgrade if we upgrade our credit rating of the Beijing government, given that there is no material change in the Beijing government’s willingness to support. Contacts Financial Summary Primary Analyst Table 1: Financial Ratios 2018A 2019A 2020F 2021F 2022F Name Winnie Guo Debt/EBITDA 12.1x 10.3x 12.8x 12.1x 11.3x Title Director Direct +852 3615 8344 EBITDA Interest Coverage 1.5x 1.7x 1.4x 1.6x 1.7x Email [email protected] Gross Debt/Capitalisation 70.8% 73.3% 74.0% 74.4% 74.8% Secondary Analyst FFO/Debt 4.1% 5.8% 3.2% 3.2% 3.2% OCF/Debt 2.4% -3.0% -0.7% 0.1% 0.0% Name Leon Li FCF/Debt -4.3% -7.1% -5.2% -3.0% -2.8% Title Analyst Direct +86 755 2348 3867 EBITDA Margin 9.5% 11.7% 10.2% 10.8% 11.4% Email [email protected] ROIC 3.8% 2.1% 2.1% 2.7% 3.2% Sources: Company, Pengyuan International’s estimates 21 January 2021 Page | 1 RA02050200009 Corporate China Key Rating Drivers Credit Strengths Strong support from the Beijing government. Wholly owned by the Beijing State-Owned Capital Operation and Management Centre （BSCOMC） and ultimately controlled by the Beijing SASAC, Shougang has a strong linkage to the Beijing government. The Beijing government controls the board and senior management appointment, and has provided capital injection and subsidies over the past few years. Shougang has taken the lead in serving as a diversified public-service provider based on the coordinated development strategy of Beijing-Tianjin-Hebei (Jingjinji) region, undertaking the construction of state-level projects of New Shougang Beijing and Caofeidian economic zone. We expect the Company to continuously receive government support, in the forms of industrial investment fund injection, subsidies and direct capital injection, in light of the importance of the projects to the state. High business diversification. Shougang has a better business diversification compared to the other steel producers in China, with non-steel related businesses contributed 27% to its revenue in 2019. We expect the Company to further diversify into non-steel related businesses in the next three years, including city infrastructure, real estate and financial service. We expect Shougang’s non-steel related businesses to generate synergies with its core business, which will continue to enhance its competitiveness. In addition, by increasing its business diversification, Shougang has diversified its cash flow and reduced its exposure to the Chinese steel industry’s cyclicality. Profitability to improve. We expect Shougang’s revenue to grow at 6.1% and 5.5% in 2021 and 2022 respectively, with EBITDA margin improving to 11.4% in 2022 from 10.2% in 2020, buoyed by the Company’s expanded steel production capacity, improving utilisation and higher prices in steel products. We expect Shougang’s capacity utilisation to increase to 80% in 2022 from 74% in 2019 with the ramp-up of its new capacity in Jingtang production base. Shougang’s steel production capacity increased to 38.4 million tonnes in 2019 from 35.3 million tonnes in 2018, driven by the completion of the one-step project of the second phase of Jingtang Iron & Steel. China steel demand to pick up. We expect China’s economic recovery to continue to support the recovery of steel industry. Infrastructure and real estate investments are expected to remain robust in 2021, thanks to the economic stimulus backed by the government. In addition, the demand of steel products for automobile and home appliance manufacturing is expected to pick up as domestic consumption increases. We expect Shougang’s cash flows to improve amid the industry recovery. Credit Weaknesses High leverage driven by ongoing capex needs. We expect Shougang’s leverage to remain high due to its coming debt redemption requirements and ongoing capex needs in the next two to three years. We expect the Company’s capex to remain high in 2021 and 2022, driven by its committed investment in mining, real estate and industrial park projects. Project investment risks. In our view, Shougang’s investment risks have arisen with its ongoing investments in new projects. The projects of New Shougang Beijing and Caofeidian economic zone have long investment cash cycle and uncertain payoffs, which might influence the profitability and cash flows of the Company. 21 January 2021 Page | 2 RA02050200009 Corporate China Table 2: Key Credit Metrics (RMB million) 2018A 2019A 2020F 2021F 2022F Financials and Profitability Revenue 205,742 202,235 198,403 210,495 222,028 EBITDA 19,638 23,591 20,310 22,642 25,252 EBITDA margin 9.5% 11.7% 10.2% 10.8% 11.4% Return on assets (ROA) 2.4% 2.5% 2.5% 3.0% 3.5% Return on invested capital (ROIC) 3.8% 2.1% 2.1% 2.7% 3.2% Cash Flow Measures Funds from operations (FFO) 9,711 14,185 8,398 8,727 9,132 Operating cash flows (OCF) 5,675 -7,225 -1,782 153 95 Free cash flow (FCF) -10,286 -17,276 -13,587 -8,168 -7,880 Discretionary cash flow (DCF) -10,411 -17,713 -13,804 -8,392 -8,131 Capital expenditure 15,961 10,052 11,805 8,321 7,976 Balance Sheet Measures Cash and liquid investments 46,965 54,256 51,566 52,781 59,369 Excess cash 32,577 41,760 39,114 40,037 46,361 Total debt 270,328 285,042 300,048 313,908 331,007 Adjusted debt 237,751 243,282 260,933 273,871 284,646 Total capitalization 381,634 388,635 405,222 421,838 442,487 Leverage Measures Debt/EBITDA 12.1x 10.3x 12.8x 12.1x 11.3x EBITDA/Interest expense 1.5x 1.7x 1.4x 1.6x 1.7x Gross debt/Capitalization 70.8% 73.3% 74.1% 74.4% 74.8% OCF/Debt 4.1% 5.8% 3.2% 3.2% 3.2% FCF/Debt 2.4% -3.0% -0.7% 0.1% 0.0% FFO/Debt -4.3% -7.1% -5.2% -3.0% -2.8% DCF/Debt -4.4% -7.3% -5.3% -3.1% -2.9% Debt/Equity 214% 235% 248% 254% 255% FFO/Cash interest expense 0.8x 1.1x 0.6x 0.6x 0.6x * EBITDA and EBITDA margin include cash dividends from equity investment Sources: Company, Pengyuan International’s estimates Business Profile Revenue to increase thanks to better production efficiencies Shougang is the sixth largest steel manufacturer in China with a steel production capacity of over 30 million tonnes. The Company’s key products include hot-rolling coils, cold-rolling coils, electric steel, heavy plates and long steel products. We expect the Company’s revenue to increase, driven by the upgrade and expansion of the capacities in the recent years. The production capacity of steel products increased to 38.4 million tonnes, as the Jingtang project initiated its pilot production after completion of construction in 2019. With the new capacity ramp-up, we expect Shougang’s capacity utilisation to increase to 80% in 2022 from 74% in 2019. Through production sites relocation and restructuring over the past decade, Shougang has optimised and upgraded its iron and steel capacity and extended its production capacity layout to coastal and resource-enriched areas. Meanwhile, the Company has shifted its product mix to more competitive products, such as high-end long sheet steel products. Exhibit 1: Capacity and utilisation Exhibit 2: Shougang is the tenth largest steel producer worldwide (2019) Million tonnes % Shougang Group 29 45 75.2 76 38.4 Tata Steel Group 30 40 36.1 35.3 75 35 75 Jianlong Group 31 28.4 30 26.2 26.5 74 Ansteel Group 39 25 74 Shagang Group 41 73.8 20 73 POSCO 43 15 72.5 73 HBIS Group 47 10 72 Nippon Steel Corporation 52 5 72 China Baowu Group 95 0 71 ArcelorMittal 2017 2018 2019 97 Steel production capacity Steel production 0 50 100 150 Million tonnes Capacity utilisation (RHS) Sources: Company, Pengyuan International Sources: Worldsteel Association, Pengyuan International 21 January 2021 Page | 3 RA02050200009 Corporate China Non-steel related businesses continue to expand Shougang has a high degree of business diversity among steel producers in China, characterised by a relatively crucial level of non-steel related business contribution.