Fitch Ratings has affirmed China-based steel producer Inner Mongolia Baotou Steel Union Co., Ltd.'s (BSUC) Long-Term Foreign-Currency Issuer Default Rating (IDR) and foreign-currency senior unsecured rating at 'BB+'.

The Outlook is Stable.

BSUC's ratings are derived from our internal assessment of the consolidated credit profile of its immediate 55% parent, Baotou Iron & Steel (Group) Co., Ltd. (BISC). BSUC's ratings are linked to the creditworthiness of BISC under our Parent and Subsidiary Linkage Rating Criteria due to strong linkages between the two entities. BISC is 77% owned by the Inner Mongolia Autonomous Region and we assess its creditworthiness based on the four factors set out in our Government-Related Entities Rating Criteria.

The Stable Outlook reflects our expectation of BSUC's steady operation, with continued operational, management and financial support from BISC.

Key Rating Drivers

Parent's Solid State Linkages: BISC is the world's largest rare earth producer and has historically received around half (55% in 2021) of the annual rare earth ore production quota issued by China's Ministry of Industry and Information Technology. BISC has China's largest reserves of rare earth and niobium, in which the country has a near monopolistic position. The government deems BISC's rare earth and niobium reserves as nationally strategic.

BISC is also the largest industrial company in the Inner Mongolia Autonomous Region by revenue and provides significant employment opportunities, with 48,300 employees at end-2021. This reinforces social stability.

'High' Operational, Strategic Incentive For Parental Support: We believe BISC has a 'High' operational and strategic inventive to support BSUC. BISC owns 55% of BSUC, which is its main steel operating subsidiary, accounting for more than 70% of the group's total assets and over 50% of consolidated EBITDA at end-2021. BISC also has absolute management control over BSUC, with significant management overlap. Meanwhile, some of group's rare earths serve as raw material for BSUC's steel products.

'Medium' Legal Incentive For Parental Support: We believe that BISC has a 'Medium' legal incentive to support BSUC, as it continuously guarantees to a significant part of BSUC's bank debt.

Persistently High Leverage: We expect BSUC's Standalone Credit Profile to stay weak amid high leverage, as measured by net debt/EBITDA. We expect net leverage to remain above 4.0x in 2022-2025 (2021: 3.3x), as the average selling price for steel is likely to drop from 2021's high levels. We expect a slight pick-up in capex in the medium term, but it should remain reasonable compared with revenue. We expect BSUC's financial flexibility metrics to remain intact, with EBITDA/interest paid maintained at above 4.0x (2021: 5.7x)

Stable Funding Provides Liquidity: BSUC had CNY22 billion in short-term debt outstanding at end-2021, against CNY5 billion of cash on hand and CNY5 billion in unused available credit facilities. Capital market debt accounts for around 40% of its total debt and about half of total debt is short-term.

We expect BSUC to be able to roll over its short-term debt, given support from BISC. BISC had CNY19 billion in unused available credit facilities at end-2021 and has reliable funding access due to strong government support and long-term relationships with major commercial and policy banks.

Derivation Summary

We rate BSUC on a top-down basis from its parent under our Parent and Subsidiary Linkage Rating Criteria. Our internal assessment of BISC's credit profile is based on our Government-Related Entities Rating Criteria.

BSUC's rating is derived under the same methodology as used for Sinochem Hong Kong (Group) Company Limited (A/Stable) and COFCO (Hong Kong) Limited (A/Stable).

Key Assumptions

Revenue to drop to below CNY80 billion in 2022 amid falling average selling prices for steel, then falling to below CNY70 billion in 2023 as we expect steel prices to continue declining.

EBITDA margin to drop to 10% in 2022 due to high raw material costs, then stabilising at 12% in 2023-2025, supported by lower input costs and a margin recovery.

Capex of around 3%-4% of revenue during 2022-2025, mainly for facility technical and environmental upgrades.

RATING SENSITIVITIES

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

An upgrade of Fitch's internal assessment of the creditworthiness of Inner Mongolia Autonomous Region

Increase in the likelihood of support from the Inner Mongolia government

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

A downgrade of Fitch's internal assessment of the creditworthiness of Inner Mongolia

Weakening of likelihood of support from the Inner Mongolia government

Weakening linkages between BISC and BSUC

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

Adequate Liquidity: BSUC had CNY22 billion in short-term debt outstanding at end 2021, compared with CNY5 billion in cash on hand and CNY5 billion in unused available credit facilities. The credit facilities were uncommitted, but we believe they are adequate, as committed facilities are uncommon in China. BSUC's debt maturity is concentrated, with short-term debt accounting for over half of total debt. We expect BSUC to be able to continue rolling over its short-term debt, given support from BISC. BSUC expects total uncommitted facilities to increase by around CNY25 billion from the end-2021 level, according to its 2022 credit facility application.

Issuer Profile

BISC is engaged in iron ore and rare earth mining and steel production and BSUC is its main operating subsidiary. BSUC has an annual steel product production capacity of around 17 million tonnes. Its main products include pipes, flat steel, section steel and long products. BSUC has expanded its business profile to include iron ore and rare earth mining in recent years, supported by asset injections from BISC.

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.

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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