Fitch Ratings has affirmed China Energy Engineering Corporation Limited's (CEEC) Long-Term Foreign-Currency Issuer Default Rating (IDR) and senior unsecured rating at 'BBB+'. The Outlook on the IDR is Stable.

We derive CEEC's ratings by applying our Government-Related Entities (GRE) Rating Criteria, as we consider CEEC's 45.06% parent, China Energy Engineering Group Co., Ltd. (CEEG), to be an intermediate holding company with no material operation or substantial debt and 'look through' the state-owned parent to the China sovereign (A+/Stable).

We notch CEEC's IDR three levels below China's Long-Term IDR, in line with the top-down approach in our criteria, to reflect CEEC's strong operational and strategic ties with the Chinese government.

The Stable Outlook reflects our expectation of continued state support for CEEC as a leading engineering and construction (E&C) company.

KEY RATING DRIVERS

'Strong' Ownership: We assess CEEC's status, ownership and control as 'Strong'. CEEG, which is 90% owned by the central State-owned Assets Supervision and Administration Commission (SASAC) and 10% owned by the National Social Security Fund, directly and indirectly owns 45.06% of CEEC with another 9.85% owned by entities controlled by the Chinese government such as China Reform Holdings Corporation Ltd. and China Securities Finance Corporation Limited.

Central SASAC effectively controls CEEC's board and senior management and has a strong influence over the group's major strategic and investment decisions. CEEC accounted for almost all of CEEG's revenue, debt and assets in 2021. The two entities also have substantial connected transactions and top management overlap.

'Strong' Financial Implications of Default: We assess the financial implications of a CEEC default as 'Strong'. CEEC is an active domestic issuer and creditors regard it as being closely associated with the government. A default by CEEC would make funding difficult for other central government-owned entities.

'Moderate' Importance and Support Record: We assess the socio-political implications of a CEEC default as 'Moderate'. Government investment in the traditional power sector has slowed, resulting in CEEC diversifying into non-power E&C businesses and expanding in the new-energy sector, which is more competitive.

We believe CEEC's business has become more commercially oriented, with a larger number of substitutes available for its services. This means a disruption to China's power E&C market, should CEEC default, would be less severe than a decade ago when it held a dominant position in the traditional power E&C sector. We also believe government support to ensure CEEC's financial stability and viability is 'Moderate', as its financial profile has remained weak for a sustained period despite a record of receiving support.

Rising Leverage: We revised CEEC's Standalone Credit Profit (SCP) to 'bb-' from 'b' to reflect its leadership in China's power construction market and strong access to funding with low financing costs, which supported its EBITDA interest coverage of 3.3x in 2021. The SCP is constrained by rising leverage from sustained operating and investing cash outflows associated with public-private partnership (PPP) and build-operate-transfer (BOT) projects. We expect CEEC's net debt/EBITDA to rise above 6.5x in 2022-2025 from 5.5x in 2021 due to a pipeline of significant investment projects.

Diversifying Beyond Conventional Energy: CEEC is expanding into new-energy businesses under the government's drive to modernise the energy generation industry, including wind and solar power. In addition, CEEC will continue diversifying into non-power construction businesses, such as integrated transport, which accounted for 31% of total construction revenue in 2021. New energy accounted for 24.1% of new construction contracts in 2021, with 53.2% growth yoy, and the non-power business contributed 50.7%, with 55.1% yoy growth.

DERIVATION SUMMARY

We notch CEEC's IDR three levels below China's Long-Term IDR in accordance with our GRE rating criteria. Our assessment of 'Moderate' socio-political implications of default is comparable with that on China State Construction Engineering Corporation Ltd (CSCECL, A/Stable), which reflects the companies' more market-driven business nature. However, the assessment is lower than that of China Communications Construction Company Limited (A-/Stable), which has a monopoly in the construction of China's civil and naval maritime facilities.

We assess CEEC's support record as 'Moderate', while we assess the factor for CSCECL as 'Strong'. This is because the financial support received by CEEC has been insufficient to lift its weak financial profile for a long period.

CEEC's closest peer is Power Construction Corporation of China (BBB+/Stable), which shares a duopoly with CEEC in China's traditional power-construction market. Our assessment of government linkage and support under our criteria for both companies is identical.

KEY ASSUMPTIONS

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

- Revenue growth of 8.5%-12.2% in 2022-2025 (2021: 19.5%)

- EBITDA margin to decline to 6.9% in 2022 and gradually narrow further to 6.3% in 2025 (2021: 7.2%)

- Capex of around CNY15 billion-19 billion per annum in 2022-2025 (2021: CNY14 billion)

- Investment cash outflow of CNY5 billion-6 billion per annum in 2022-2025 associated with equity investments on PPP and BOT projects

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 of likelihood of support from the Chinese government.

For the sovereign rating of China, the following sensitivities were outlined by Fitch in our rating action commentary of 2 June 2022:

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

- Structural Features: A continued rise in macro-financial risks, for example through failure to maintain credit growth at a level close to nominal GDP growth over the next few years.

- Public Finances: A sharp upward trend in government debt/GDP or a crystallisation of contingent liabilities that leads to a significant rise in government debt relative to 'A' peers.

- External Finances: Sustained capital outflows sufficient to erode China's external balance-sheet strengths relative to 'A' peers, which would cause the removal of the +1 Qualitative Overlay (QO) notch on External Finances.

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

Adequate Liquidity: CEEC had around CNY48.3 billion of short-term debt at end-2021, which can be sufficiently covered by CNY52.7 billion in available cash. In addition, CEEC has around CNY727 billion of unused bank facilities. The facilities are uncommitted as committed facilities are uncommon in China's banking system.

ISSUER PROFILE

CEEC dominates China's thermal power E&C market and also participates in E&C for clean energy segments, such as hydro, wind, solar and nuclear power. It carries out power-plant design and construction, with exposure to ancillary segments, including high-voltage power grids, cement, environmental protection, water treatment, real estate and civil explosives.

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

CEEC's ratings are linked to China's rating under Fitch's GRE 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.