Rating Action Overview

• Beijing Capital Group Co. Ltd.'s (BCG) growing operational income from infrastructure and utilities segments should partially offset earnings volatility from its property division.
• The Beijing-based utility and property developer continues to benefit from good access to funding and its strong link to China's capital city government.
• On Nov. 15, 2023, S&P Global Ratings affirmed its 'BBB-' long-term issuer credit rating on BCG. At the same time, we affirmed our 'BBB-' long-term issue rating on the senior unsecured notes the company guarantees.
• The stable outlook reflects our view that BCG will recover business scale through a diversified earnings stream over the next two years, allowing it to gradually reduce its debt load despite property market headwinds.

Rating Action Rationale

We affirmed the rating because we believe BCG's increasing operating income from utilities and infrastructure segment will help stabilize its earnings volatility amid a property downturn. Meanwhile, the company's funding access remains solid despite the prospect of slower deleveraging than we anticipated.

Diversified funding access and solid relationships with banks will continue to support BCG's credit profile despite slower than expected deleveraging.  We estimate that BCG will remain highly leveraged, with a debt-to-EBITDA ratio hovering around 14x for the next one to two years, compared with 15.2x in 2022. That said, as a state-owned enterprise (SOE), the company's funding access remains solid. Its average funding cost dropped to 4.3% in 2023. The company, including its property development arm, have raised more than Chinese renminbi (RMB) 15 billion via capital markets in 2023, similar to last year. Due to its declining funding costs, BCG's interest-serving ability should strengthen, with EBITDA interest coverage likely to improve toward 1.5x-1.8x over 2024-2025, from 1.2x in 2022.

BCG's strategic property transition will hinge on policy developments and government support.  We believe the business profile of BCG's property development arm has weakened in terms of sales execution and geographic coverage. The unit has experienced continuous sales and margin moderation. In view of the lingering sector downturn, BCG is gradually shifting the focus of its property arm from property development to policy-driven projects, particularly in the Beijing-Tianjin region amid the sector downturn. However, such a transition hinges on policy rollouts and is subject to high uncertainty. In the meantime, we expect more earning volatility from the property arm over the next one to two years, as revenue and margins diminish.

Increasing operating income from utilities and infrastructure segment will help cushion property volatility.  As a conglomerate, BCG's diversified earning sources could partially smooth earnings fluctuations. By our estimate, utilities and infrastructure will generate over 50% of BCG's EBITDA over the next two to three years. In the first half of 2023, operational income from BCG's utilities segment increased by roughly 11%, with new water supply and sewage treatment projects launched during the period. We expect solid growth in BCG's infrastructure segment, from its metro operation in Beijing, thanks to a usage increase post-pandemic, and a new line starting operations in 2022.

Controlled investment appetite supports debt reduction in the next two to three years, despite operational headwinds in the next one to two years. We expect BCG to stay committed to its debt reduction plan in the longer term and to remain prudent in its investment and capex decisions. The company has not acquired land on the open market since 2022. About 80% of its new utility and environment projects in the first half of 2023 are asset-light, requiring little capital expenditure (capex) contribution from BCG. In the first nine months of 2023, BCG's capex decreased by 35.2%, to RMB 5 billion, compared with the same period in 2022.

As a Beijing Municipality government-related entity (GRE), BCG continues to benefit from a high likelihood of timely and sufficient extraordinary government support in the event of distress, in our assessment. This support results in three notches of uplift from its stand-alone credit profile (SACP), leading to a final rating of 'BBB-'. In our view, BCG retains its important role in providing water supply and sewage treatment, transportation, waste treatment and micro finance to Beijing's residents, although at a lesser scale than other public utility-focused GREs. BCG is also involved in the Beijing-Tianjin-Hebei integration development, using the company's large landbank in Tianjin, and provides social housing and urban renewal services in Beijing.

Outlook

The stable outlook reflects our expectation that the company will recover its business scale with diversified earnings stream over the next two years, while gradually reducing its debt load, despite property market headwinds. We anticipate the company will continue to enjoy good funding access as a key SOE in Beijing and the capital city's government will continue to support BCG with asset injections and project access.

Downside scenario

We could lower the rating if BCG fails to execute its debt-reduction plan; or the company's earnings diversification noticeably weakens; or its earnings and cash flow are significantly weaker than we expect due to challenging operating conditions, such that its deleveraging trend materially reverses.

We may also lower the rating if the company's link with, and importance to, the Beijing government weakens.

Upside scenario

We could raise the rating if BCG adopts more prudent financial management and growth strategies, such that its ratio of debt to EBITDA improves to close to 5x.

We could also raise the rating if the company's link with, and importance to, the Beijing government strengthens.

Company Description

BCG was established in 1994 as one of the largest and most profitable state-owned enterprises (SOEs) under the Beijing government. BCG has four major business lines--water and environment services, real estate development, transportation infrastructure, and financial services.

The company has two flagship subsidiaries in its water treatment and property development business segments. BCG owns 47.05% of Beijing Capital Eco-environment Protection Group Co. Ltd., which is listed on the Shanghai stock exchange and completed a RMB2.7 billion private rights offering in November 2018. This subsidiary is the group's platform for the water, sewage, and solid waste treatment businesses, as well as the parent of Hong Kong-listed Capital Environment Co. Ltd.

BCG engages in property development, mainly through its newly established platform, Beijing Capital City Development Group Co. Ltd. (BCCD), which owns the privatized Beijing Capital Land Ltd., Capital Jingzhong, and other property-related subsidiaries. BCG conducts social housing projects and primary land development through its unlisted BCCD subsidiary.

Our Base-Case Scenario

Assumptions

• China's real GDP to grow 4.8% in 2023 and 4.4% in 2024, compared with 3.0% growth in 2022. Real GDP growth in the Beijing Municipality area to be in line with China's.
• We forecast China's property sales will drop by 10%-15% to RMB11.5 trillion-RMB12 trillion in 2023 and further decline by another 5% to RMB11 trillion-RMB11.5 trillion in 2024.
• BCG's revenue for the utilities and environmental segment to decrease by 5%-7% in 2023 due to the full-year impact of the disposal of New Zealand assets, followed by an increase of 8%-10% in 2024.
• BCG's revenue from property development to decline by about 0%-2% in 2023, before recovering by 1%-3% in 2024.
• Transportation revenue to increase by 18%-20% in 2023 and 5%-7% in 2024, as the pandemic recedes and new lines start operation.
• Gross margin to remain relatively stable around 31%-33% in 2023 and 2024, compared with 32.0% in 2022.
• Capex to range from RMB8 billion-RMB9 billion per annum in 2023-2024, compared with RMB9.4 billion in 2022.
• Government subsidy: annual operational subsidy, adjusted each year to recover operating losses from metro construction and other national utility businesses, of RMB350 million-RMB450 million in 2023-2024.
• Adjusted debt to decrease to RMB192 billion-RMB194 billion in 2023 and 2024, compared with RMB199.2 billion in 2022.
• Cash holdings to marginally decrease to RMB53 billion-RMB58 billion in 2023-2024, from RMB59.2 billion in 2022.

Based on these assumptions, we arrive at the following credit measures:

• Ratio of debt to EBITDA of 14.6x-14.8x in 2023 and 13.6x-13.8x in 2024, from 15.4x in 2022.
• EBITDA interest coverage of 1.2x-1.4x in 2023 and 1.5x-1.7x in 2024, from 1.2x in 2022.

Liquidity

We assess BCG's liquidity as adequate, because we expect the company's ratio of liquidity sources to its uses at about 1.4x over the 12 months ending Sept. 30, 2024.

Given the company's SOE background, it has strong banking relationships allowing it to access sufficient onshore bank loans, especially with the big four state-owned banks and banks owned by the Beijing State-owned Assets Supervision and Administration Commission, such as Bank of Beijing and Beijing Rural Commercial Bank. Those six banks together make up more than RMB135.7 billion out of the group's RMB300.7 billion of total bank credit lines as of end-2022.

BCG also has a satisfactory standing in credit markets onshore and offshore, which is supported by its low coupon rate. For instance, in July 2023, the company issued RMB1.5 billion onshore bonds with a coupon rate of about 3.05%.

BCG also has a degree of flexibility to lower capex and acquisition spending, if needed.

Principal liquidity sources:

• Unrestricted cash balance estimated at RMB65.2 billion as of Sept. 30, 2023.
• Cash funds from operations of RMB4.8 billion in the next 12 months, prior to land acquisitions.
• Working capital inflow of RMB1.3 billion in the next 12 months.

Principal liquidity uses:

• Debt due in the next 12 months of RMB40.6 billion by our estimate as of Sept. 30, 2023.
• Capex that we estimate at RMB8.0 billion-RMB9.0 billion in the next 12 months.
• Dividend payments and cash distribution for perpetual securities of RMB1.7 billion.

Issue Ratings - Subordination Risk Analysis

Capital structure

As of Dec. 31, 2022, BCG's capital structure consisted of RMB59.0 billion in secured debt and RMB164.9 billion in unsecured debt, including perpetual securities and guarantees. Most of BCG's unsecured debts are at the subsidiary level, which collectively owe RMB130.7 billion, resulting in a priority debt ratio of 84.7%.

Analytical conclusions

We equalize the BCG senior unsecured issue rating with our issuer credit rating on the company because we see a high likelihood of extraordinary government support, given BCG's government-related status. In our view, this can largely mitigate the structural subordination risk on debt issued at the BCG parent level.

Ratings Score Snapshot

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