Fitch Affirms Beijing Enterprises Holdings at 'A'; Outlook Stable

Fitch Ratings has affirmed Beijing Enterprises Holdings Limited's (BEHL) Long-Term Issuer Default Rating (IDR) and senior unsecured rating at 'A'.

The Outlook is Stable.

Fitch has simultaneously affirmed the 'A' rating on all of BEHL's existing US dollar and euro bonds that are unconditionally and irrevocably guaranteed by BEHL.

BEHL's IDR is aligned with Fitch's internal credit assessment of the 62.4% parent, Beijing Enterprises Group (BEG), based on our Parent and Subsidiary Linkage Rating Criteria and driven by BEG's 'High' strategic and operational incentives to support BEHL. BEHL holds BEG's strategic assets and contributes the majority of its EBITDA.

Our assessment of BEG is linked to, but not equalised with, our internal assessment of the creditworthiness of Beijing municipality, based on the Government-Related Entities (GRE) Rating Criteria. BEG is wholly owned by the Beijing State-owned Assets Supervision and Administration Commission. We expect a high likelihood of government support due to BEG's strategic role as the city's integrated municipal utilities and public-service platform.

Key Rating Drivers

Parent's 'Strong' State Linkage: We assess BEG's status, ownership and control by the state as 'Very Strong'. The Beijing municipal government appoints key management and has tight control over BEG's strategies and operations. BEG's role as the city's state-owned capital investment and operation platform in the utilities sector is closely aligned with the government's economic and public planning. We assess BEG's support record as 'Strong', reflecting its frequent government grants and equity injections, as well as policy support for its gas business in Beijing.

Parent's 'Strong' Implications of Default: We assess the socio-political implications of a BEG default as 'Strong'. It would be difficult to find substitutes should BEG default, given its broad policy mandate. BEG supplies 95% of the gas in Beijing and operates some of the city's water and waste projects via subsidiaries. It was also mandated to build symbolic infrastructure projects. The financial implications of a default are assessed as 'Strong'. BEG and its subsidiaries are frequent issuers in domestic and offshore bond markets, and its default would jeopardise access to funding for other Beijing GREs.

'High' Strategic Incentive: BEHL's financial contribution to BEG is assessed as 'High' because it accounts for 53% of BEG's EBITDA and 45% of assets. Competitive advantage is also 'High', as the company holds BEG's most strategic public utilities, including natural gas distribution, water and solid waste treatment.

BEHL has a critical role of executing key municipal mandates on energy security and environmental protection on BEG's behalf. BEHL is also an important funding platform for BEG with access to overseas equity and debt markets. Its growth potential is assessed as 'Medium', reflecting the moderate prospects of growth in Beijing's natural gas consumption and BEHL's waste and water segments.

'High' Operational Incentive: The high degree of brand and management overlap outweighs the low level of operational synergy between BEHL and BEG. The majority of BEHL's executive directors have also served on BEG's management team, and management rotation occurs between the two. BEG has significant influence over BEHL's strategic, financial and operational decisions. BEHL and some of its subsidiaries also share the same brand name as BEG, and are widely considered as part of BEG by major creditors.

'Medium' Legal Incentive: Our 'Medium' assessment reflects the potential for BEHL to trigger the cross-default clause on some of BEG's domestic debt instruments, which have a large outstanding amount and a certain degree of permanency.

Stable Gas Business: We expect the dollar margin of Beijing Gas Group Co., Ltd. (A/Stable), a subsidiary of BEHL, to remain stable over 2023-2025 due to its stable procurement costs for piped gas and well-established pricing system. We expect its gas sales volume to decline slightly in 2023 over warm weather, but we believe the easing of Covid-19 restrictions will support economic activities and gas sales in 2H23.

Asset-Light Water Business: We expect BEHL's water business to continue improving its free cash flow generation following its adoption of an asset-light strategy. The business will lower its exposure to build-operate-transfer construction and water environmental renovation projects, focusing on service-driven projects with lower capex intensity.

Weaker Margin for Waste Treatment: We expect the EBITDA margin to drop by 6.5pp in FY23, mainly from lower gate fees, lower commercial & industrial (C&I) waste intake and higher costs for the European businesses, which led to a EBITDA decline of 26%. We believe EBITDA will gradually recover after 2023 as operating capacity increases, while margin should recover gradually with the normalisation of C&I waste volumes and favourable electricity prices.

Higher Leverage: BEHL's leverage, measured by EBITDA net leverage after proportionately consolidating BE Water, rose to 5.0x in 2022 from 4.3x in 2021 due to lower EBITDA from the waste treatment business and higher capex. We expect leverage to remain high at around 5.0x on higher capex from the Nangang LNG terminal and EEW Energy from Waste GmbH (BBB/Negative), before gradually trending lower after 2024 as previous capex translates into higher earnings.

'bbb' SCP: Our assessment of BEHL's Standalone Credit Profile (SCP) is underpinned by the stable cash flow from its core operations and moderate leverage.

Derivation Summary

BEHL's ratings are equalised with our internal assessment of the parent, BEG, because of strong parent-subsidiary linkages, based on 'Medium' legal, 'High' strategic and 'High' operational incentives to support.

Key Assumptions

Fitch's Key Assumptions Within Our Rating Case for the Issuer:

Beijing Gas: Dollar margin remains stable at CNY0.38/cubic metre over 2023-2025. Gas volume drops in 2023 on warmer temperatures, then sees steady growth of 1%-2% between 2024 and 2026.

BE Water: Proportion of construction revenue declines during 2023-2026 to reflect the change of strategy towards an asset-light model; 2.3 million-2.8 million tonnes a day of additional water supply and wastewater treatment capacity to be operational during 2023-2026, with a stable margin.

Beijing Yanjing Brewery Co., Ltd: We factor in an annual volume increase of 4%-5% during 2023-26, driven by high-end products, with average selling prices increasing by 3% per year to reflect product premiumisation.

China Gas: Retail gas sales volume achieves a CAGR of 7% during FY24-FY27. Dollar margin improves by CNY0.08/cubic metre in FY24 on better cost pass-through and lower spot gas prices.

BEHL's dividend payout ratio rises to 35% in 2026, from 27% in 2022.

BEHL's capex rises to HKD15.2 billion in 2023, from HKD13.4 billion in 2022, before gradually lowering to below HKD9 billion by 2026.

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to positive rating action/upgrade:

Improvement in Fitch's internal assessment of the creditworthiness of BEG, provided BEG's incentive to support BEHL remains unchanged.

Factors that could, individually or collectively, lead to negative rating action/downgrade:

Evidence of weakening incentive to support by BEG;

Lowering of Fitch's internal assessment of the creditworthiness of BEG.

Best/Worst Case Rating Scenario

International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.

Liquidity and Debt Structure

Comfortable Liquidity: The company had total borrowings of HKD77.4 billion as of end-FY22, of which HKD24.6 billion was maturing in one year. Short-term debt accounted for 32% of total debt. The company has HKD31.3 billion in available cash on hand, more than sufficient to cover its short-term obligations. Offshore debt accounted for 86% of total borrowings by end-FY22, but 33% of the offshore debt was long-dated with fixed interest rates. We believe BEHL has the resources to refinance the high-interest offshore debt if needed.

Issuer Profile

BEHL, which is majority owned by BEG, is mainly engaged in city gas distribution, brewery, water and waste treatment businesses.

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

Public Ratings with Credit Linkage to other ratings

BEHL's ratings are linked to Fitch's internal assessment of the creditworthiness of BEG.

ESG Considerations

The highest level of ESG credit relevance is a score of '3', unless otherwise disclosed in this section. A score of '3' means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. Fitch's ESG Relevance Scores are not inputs in the rating process; they are an observation on the relevance and materiality of ESG factors in the rating decision. For more information on Fitch's ESG Relevance Scores, visit https://www.fitchratings.com/topics/esg/products#esg-relevance-scores.