Fitch Ratings has affirmed China Railway Group Limited's (CRG) Long-Term Issuer Default Rating (IDR) and senior unsecured rating at 'A-'.

The Outlook is Stable.

CRG's parent, China Railway Engineering Group Company Limited (CREC), is 90% owned by the State-owned Assets Supervision and Administration Commission (SASAC) and 10% by the National Social Security Fund (NSSF). CRG accounts for almost all of CREC's revenue, profit, debt, cash and assets.

The two entities also have substantial overlap in top management. We used our Government-Related Entities (GRE) Rating Criteria to derive CRG's rating, as we regard CREC as an intermediate holding company with no material operations or substantial debt and look through CREC to the Chinese sovereign (A+/Stable).

Fitch rates CRG using a top-down approach with a score of 30 points under the GRE criteria, based on the government's incentive to provide support and the company's linkage with the government. CRG's IDR is notched down twice from the sovereign's IDR. The Stable Outlook reflects Fitch's expectation of continued state support for CRG.

CRG's Standalone Credit Profile (SCP) of 'bb-' is supported by its strong business profile and access to funding. The SCP is constrained by its rising financial leverage due to investment in public-private partnerships (PPP) and build-operate-transfer (BOT) projects.

Key Rating Drivers

'Strong' Ownership, Support Record: Fitch assesses CRG's status, ownership and control as 'Strong'. The state fully owns CREC, which is CRG's largest shareholder with a 46.96% stake at end-2022. The rest of CRG is held by other shareholders including state-owned China Reform Holdings Corp Ltd and Central Huijin Asset Management Ltd. CREC has high influence over CRG's major strategies and investment decisions. We assess CRG's support record as 'Strong', as it has received direct tangible state support in grants, capital injections and tax rebates as well as significant support from policy banks.

'Strong' Support Incentive: We assess the socio-political implications of a CRG default as 'Strong', as it would significantly disrupt China's railway development plan. The plan is pivotal to the country's continuing urbanisation, a high-profile political goal. It could also affect China's geopolitical goals, as railway construction is important for the country's foreign policy. In addition, we assess the financial implications of a default as 'Strong'. CRG is an active domestic and international bond issuer; a default could harm access to capital markets for the sovereign and other GREs.

Solid Infrastructure Market Positions: CRG maintained its solid position in China's railway construction market, with around 40%-50% share of large and medium-sized railway projects in recent years. Fitch believes CRG's position as one of two companies that dominate China's railway construction market will continue to support its leading position in the infrastructure engineering and construction market.

The government strictly monitors the railway construction sector, from budgeting, ordering and quality to licences. This oversight creates high entry barriers. CRG holds 18 special-grade general contracting qualifications for railway projects, accounting for over 50% of the total number of special-grade qualifications for railway construction in China. CRG also maintained its leading position in China's urban rail transit and expressway markets on its technical strength in design, survey and construction.

Expansion Outside Railway Market: We expect CRG to continue expanding non-railway construction segments given sustained weakness in railway investment. The contribution of railway projects to CRG's revenue and gross profit has declined steadily, reaching 21% and 7%, respectively, in 2022 from peaks of 50% and 43% in 2009. Even so, CRG has accelerated expansion in what it calls second-curve business, including water resources, hydropower and renewable energy. New contract signings in the second-curve business surged by 81% in 2022 while total new infrastructure construction contracts rose by 10%.

We believe that CRG can build solid footprints in new markets related to the second-curve business and gain market shares from incumbents, in particular, from those private contractors, given its strength in operation scale, solid record in infrastructure projects, funding access and construction qualifications.

Improved Cash Flow Generation: CRG reported a net cash flow from operations (CFO) of over CNY43 billion in 2022, up substantially from CNY13 billion in 2021, on strengthened cash collection. The improvement was sustained in 1Q23, with reported operating cash outflow narrowing to CNY38 billion from an outflow of CNY49 billion in 1Q22. We expect CRG to continue focusing on receivables collection and cash flow management, as the SASAC has replaced the operating profit margin with the CFO/revenue ratio in the central state-owned enterprises' performance review metrics since 2023.

Slower Pace in Leverage Build-up: We expect CRG's build-up in leverage to be slower in the coming years than we previously expected as operating cash flow generation gradually improves and the company takes a more cautious and selective approach on investment-driven projects, including PPP and BOT. That said, CRG's net debt/EBITDA is likely to continue increasing to around 6.6x in 2023-2026, from 5.9x in 2022, on funding requirements related to PPP and BOT projects in pipeline and second-curve business, such as the Yunnan Dianzhong water diversion project.

Derivation Summary

CRG's strategic importance to the sovereign is similar to that of other large infrastructure construction companies that operate in sub-segments that have only one or two dominant competitors. For example, China Communications Construction Company Limited (CCCC, A-/Stable), which builds high-grade roads, bridges and maritime facilities. CCCC is also rated on a top-down basis and two notches below the sovereign rating, in line with Fitch's GRE criteria, reflecting its similarly strong importance to the sovereign.

CRG's 'Strong' support record assessment is higher than that of CCCC, as CRG has a stronger financial profile with lower leverage.

Key Assumptions

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

Revenue growth of 4.6%-6.5% in 2023-2026 (2022: 7.6%);

EBITDA margin of 5.2% in 2023-2026 (2022: 5.2%);

Capex of CNY56 billion-61 billion a year in 2023-2026 (2022: CNY62 billion).

RATING SENSITIVITIES

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

Positive rating action on the Chinese sovereign;

Strengthening of likelihood of support from the Chinese government.

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

Negative rating action on the Chinese sovereign;

Weakening linkages between CRG and CREC;

Weakening of likelihood of support from the Chinese government.

CRG is rated two notches below China's sovereign rating. Under Fitch's GRE criteria, a one-notch change of the SCP would not automatically result in a change to the IDR.

For the sovereign rating of China, the following sensitivities were outlined by Fitch in our rating action commentary of 15 December 2022:

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

Public Finances: A sustained upward trajectory in government debt/GDP or a rise of contingent liabilities, such that debt levels compare less favourably with rated peers.

Macro: The recurrence of abrupt policy shifts that undermine economic performance and keep growth volatility at elevated levels.

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

Structural Features: A material reduction in macro-financial risks and associated contingent liabilities facing the sovereign, for example, by maintaining credit growth below nominal GDP growth over a multi-year period, which would cause the removal of the -1 QO notch on Structural Features.

External Finances: Widespread adoption of the Chinese yuan as a reserve currency, as reflected in a substantial increase in the share of yuan-denominated claims in the IMF's currency composition of official foreign exchange reserves (COFER) database.

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

Sufficient Liquidity: CRG had short-term debt of around CNY165 billion at end-2022, which could be fully covered by available cash of over CNY200 billion. In addition, CRG had undrawn bank facilities of over CNY1,500 billion. However, these facilities are uncommitted, as committed facilities are uncommon in China's banking system.

Issuer Profile

CRG shares a duopoly with China Railway Construction Corporation Limited in China's railway construction market. CRG, ranked the world's second-largest engineering and construction company by Engineering News-Record in 2022, provides a full range of construction-related services.

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

CRG is rated two notches below China's sovereign rating under Fitch's GRE rating criteria.

ESG Considerations

Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This 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. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg

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