Fitch Places Yanzhou Coal on Rating Watch Positive Following Parent's Merger Announcement

(The following statement was released by the rating agency) Fitch Ratings-Hong Kong-15 July 2020: Fitch Ratings has placed Yanzhou Coal Mining Company Limited's Long-Term Issuer Default Rating and senior unsecured rating of 'BB-' on Rating Watch Positive (RWP). At the same time, Fitch has placed the 'BB-' rating on Yanzhou Coal's USD550 million 5.73% senior unsecured notes due 2022 on RWP. The notes are issued by Yancoal International Resources Development Co., Limited, a wholly owned subsidiary, and unconditionally and irrevocably guaranteed by Yanzhou Coal. The RWP reflects Fitch's expectation that when the merger of Yankuang Group Co., Ltd., which owns 51.8% of Yanzhou Coal, and Shandong Energy Group Co., Ltd is completed, the combined entity will have a stronger likelihood of support from Shandong province than Yankuang has currently due to the enhanced strategic role in coal supply and leading position among state-owned-enterprises (SOE) in Shandong province. We await further clarity on the deal, including timeline for completion, potential asset restructuring and integration, among others. Still, we are likely to assess the credit profile of the combined entity under a top-down approach from Fitch's internal assessment of the credit worthiness of the Shandong province, based on Fitch's Government-Related Entities (GRE) Rating Criteria. In addition, Fitch is likely to rate Yanzhou Coal based on a top-down approach on completion of the merger, under our Parent Subsidiary Rating Linkage criteria, as we expect Yanzhou Coal's linkage with the combined entity's to be strong. We expect to resolve the RWP on completion of the merger. Key Rating Drivers Parent's Merger with Shandong Energy: Yanzhou Coal announced on 12 July that its parent, Yankuang, plans to merge with Shandong Energy, the other provincial coal mining SOE in Shandong province. Multiple Chinese news media outlets reported that a government meeting hosted by the head of the Shandong State-owned Asset Supervision and Administration Commission (SASAC) was held on 13 July to announce the merger. Yankuang's chairman will become the chairman of the combined entity. We believe the merger is being driven by the Shandong SASAC's SOE reform agenda, which aims to reduce the number of provincial SOEs and increase their asset return. Strengthened Likelihood of Support: The combined entity is likely to receive stronger likelihood of support that warrants a top-down approach in assessing its credit profile under Fitch's GRE criteria. Yankuang and Shandong Energy combined account for most of the coal production in Shandong and meet around 40% of the province's coal consumption. Fitch regards partial self-sufficiency of coal facilitated by Yankuang and Shandong Energy as important to Shandong province due to the energy-intensive economy. In addition, individually Yankuang and Shandong Energy are among the top five largest provincial SOEs in Shandong in terms of assets. The combined entity will rank the second in asset and equity size, next to the combined entity of Shandong High-speed Group Co., Ltd. (SHS, A/Stable) and Qilu Transportation Development Group Co., Ltd. (A/Stable), and the first in the scale of revenue, profit and cash flow. Strong Linkage: Fitch expects to rate Yanzhou Coal based on a top-down approach from its parent after the merger, as the linkage between Yanzhou Coal and the combined entity is likely to remain strong. Yanzhou Coal will remain the combined entity's only listed subsidiary engaged in coal mining other than Yanzhou Coal's subsidiary Yancoal Australia Ltd. Fitch estimates Yanzhou Coal contributes around 45% of the combined entity's coal production and a third of its EBITDA as of 2019 and holds most of the overseas coal mines. In addition, Yankuang guarantees CNY12.8 billion of Yanzhou's debt as of end-2019, which Fitch views as strong tangible support. Stronger Standalone Profile of Parent: Fitch expects the combined entity to have a stronger Standalone Credit Profile (SCP) than 'b-' due to its significantly larger scale and a better free cash flow (FCF) profile compared with Yankuang. Yankuang and Shandong Energy combined will be the second-largest coal mining company in China after China Energy Investment Corporation Limited. The average mine life and cost position of Shandong Energy's coal mines are comparable with those of Yankuang. Fitch estimates 2019 fund from operations (FFO) net leverage of 5.7x for the combined group on a pro forma basis, compared with Yankuang's 5.8x. The FCF of the combined entity is likely to be better than that of Yankuang due to Shandong Energy's stronger operating cash flow and more conservative capex. Derivation Summary Yanzhou Coal's rating is based on the consolidated credit profile of Yankuang, reflecting the moderate linkage between the two entities under Fitch's Parent and Subsidiary Rating Linkage criteria. Yankuang's consolidated credit profile incorporates an uplift from its standalone profile based on our GRE criteria. Yankuang's assessment of 'Strong' under the status, ownership and control factor is lower than that of SHS due to exceptionally high degree of government control over the latter's strategic and investment decisions as a key provincial infrastructure investment platform, while Yankuang's business is more commercially oriented. Yankuang's 'Moderate' support record and 'Strong' financial implications of a default are in line with the assessment for other large provincial SOEs in the energy or commodity sectors, including Gansu Province Electric Power Investment Group Co., Ltd. (BBB-/Stable) and Jiuquan Iron and Steel (Group) Co., Ltd. (BBB-/Stable). The 'Weak' assessment of the socio-political impact of a default takes into account Yankuang's large asset exposure outside Shandong province as well as the province's heavy reliance on coal supply from other provinces. Yankuang's SCP of 'b-' is comparable with that of HBIS Group Co., Ltd. (BBB+/Stable; SCP: b-). Both are big companies in their respective sectors, coal mining and steel. Yankuang and HBIS have similar operating scales and single-digit market shares in industries with many smaller companies. The SCPs of both companies are constrained by their weak financial profiles, which are characterised by higher leverage and structurally negative FCF. Yankuang's FFO net leverage averaged 8.5x in 2015-2018, a similar level to HBIS's 9.1x. Key Assumptions Fitch's Key Assumptions Within Our Rating Case for the Issuer - Average selling price of self-produced coal at CNY512/tonne in 2019, CNY477/tonne in 2020, CNY473/tonne in 2021 and CNY468/tonne in 2022; - Unit coal production cost to remain flat in the coming years; - Coal production to rise at 2.2% CAGR in 2019-2022; - Annual capex averaging CNY7.3 billion in 2019-2022 and on a downward trend. RATING SENSITIVITIES Factors that could, individually or collectively, lead to positive rating action/upgrade: - Fitch may upgrade Yanzhou Coal's ratings by more than one notch upon completion of the announced merger Factors that could, individually or collectively, lead to negative rating action/downgrade: - The RWP will be resolved and the rating will be affirmed at 'BB-' if the merger is not completed. 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: Yanzhou Coal had readily available cash of CNY22.8 billion by end-2019 (end-2018: CNY27.4 billion), enough to cover its debt maturing within one year of CNY16.2 billion (end-2018: CNY20.1 billion). The company also had total undrawn bank credit facilities of CNY62.3 billion as of end-2019. Fitch expects the company to continue to benefit from strong access to domestic funding sources due to its large SOE status. 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. Yanzhou Coal Mining Company Limited; Long Term Issuer Default Rating; Rating Watch On; BB-; RW: Pos ----senior unsecured; Long Term Rating; Rating Watch On; BB-; RW: Pos Yancoal International Resources Development Co., Limited ----senior unsecured; Long Term Rating; Rating Watch On; BB-; RW: Pos Contacts: Primary Rating Analyst Diana Xia, Associate Director +852 2263 9630 Fitch (Hong Kong) Limited 19/F Man Yee Building 60-68 Des Voeux Road Central Hong Kong Secondary Rating Analyst Wei Yu, Director +86 21 6898 7983 Committee Chairperson Penny Chen, Senior Director +86 21 6898 7996 Media Relations: Alanis Ko, Hong Kong, Tel: +852 2263 9953, Email: alanis.ko@thefitchgroup.com Wai Lun Wan, Hong Kong, Tel: +852 2263 9935, Email: wailun.wan@thefitchgroup.com Additional information is available on www.fitchratings.com Applicable Criteria Corporate Rating Criteria (pub. 01 May 2020) (including rating assumption sensitivity) (https://www.fitchratings.com/site/re/10120170) Corporates Notching and Recovery Ratings Criteria (pub. 14 Oct 2019) (including rating assumption sensitivity) (https://www.fitchratings.com/site/re/10090792) Country-Specific Treatment of Recovery Ratings Rating Criteria (pub. 27 Feb 2020) (https://www.fitchratings.com/site/re/10111386) Government-Related Entities Rating Criteria (pub. 13 Nov 2019) (https://www.fitchratings.com/site/re/10099139) Parent and Subsidiary Rating Linkage (pub. 27 Sep 2019) (https://www.fitchratings.com/site/re/10089196) Sector Navigators - Addendum to the Corporate Rating Criteria (pub. 26 Jun 2020) (https://www.fitchratings.com/site/re/10125796) Additional Disclosures Solicitation Status (https://www.fitchratings.com/site/pr/10129811#solicitation) Endorsement Status (https://www.fitchratings.com/site/pr/10129811#endorsement_status) Endorsement Policy (https://www.fitchratings.com/site/pr/10129811#endorsement-policy) ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. 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