Sector Review:

Asia-Pacific Credit Trends 2014: Mining Companies' Credit Metrics Will Mend Slowly; Oil And Gas Firms Foresee Higher Demand
Primary Credit Analysts: May Zhong, Melbourne (61) 3-9631-2164; may.zhong@standardandpoors.com Lawrence Lu, CFA, Hong Kong (852) 2533-3517; law.lu@standardandpoors.com Secondary Contacts: Sangyun Han, Hong Kong (852) 2533-3526; sangyun.han@standardandpoors.com Xavier Jean, Singapore (65) 6239-6346; xavier.jean@standardandpoors.com Gloria Lu, CFA, FRM, Hong Kong (852) 2533-3596; gloria.lu@standardandpoors.com Andrew M Wong, Singapore (65) 6239-6306; andrew.wong@standardandpoors.com

Table Of Contents
Slow Recovery In Credit Metrics For Metals And Minerals Companies Sector Outlook Key Risks And Trends Ask The Analyst Oil And Gas Fortunes Will Rise And Fall In Line With Economic Conditions Sector Outlook Key Risks And Trends Ask The Analyst Related Research
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Sector Review:

Asia-Pacific Credit Trends 2014: Mining Companies' Credit Metrics Will Mend Slowly; Oil And Gas Firms Foresee Higher Demand
(Editor's Note: This article is part of a series on the credit trends of Asia-Pacific's corporate sectors for 2014. The series responds to analytical queries received recently on a sector or a specific issuer in that sector.)

Slow Recovery In Credit Metrics For Metals And Minerals Companies

Analysts: May Zhong, Xavier Jean, Sangyun Han

Sector Outlook
Standard & Poor's Ratings Services expects the negative credit outlook for the Asia-Pacific metals and mining sector to moderate in 2014 (see table 1). Our forecasts for the Asia-Pacific mining sector show that most companies' profitability and credit metrics should bottom out in 2013 (see charts 1, 2, and 3). Supporting this view are three key factors: 1) a ramp-up in volumes across the sector; 2) a leveling of operating margins in 2013 because of companies' initiatives to cut operating costs and improve productivity in response to low commodity prices; 3) deferral of growth capital expenditure to preserve cash.
Table 1

Asia-Pacific Metals and Minerals Sector

Business conditions Business outlook Financial trend Sector outlook Weak No change Slightly improving Negative

Nonetheless, we expect the improvement in credit metrics will be slow and modest. Commodity prices are unlikely to bounce back strongly in the next 12-18 months because of pockets of oversupply for certain minerals, such as coking and thermal coal and nickel, and metals such as steel and aluminum. The weak commodity prices would hamper a strong recovery in earnings and cash flows. In monitoring the sector's credit quality, we also focus on the liquidity levels of weaker companies, including their operating cost and working capital management, control over stripping costs, and refinancing activity.

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Sector Review: Asia-Pacific Credit Trends 2014: Mining Companies' Credit Metrics Will Mend Slowly; Oil And Gas Firms Foresee Higher Demand

Chart 1

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Sector Review: Asia-Pacific Credit Trends 2014: Mining Companies' Credit Metrics Will Mend Slowly; Oil And Gas Firms Foresee Higher Demand

Chart 2

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Sector Review: Asia-Pacific Credit Trends 2014: Mining Companies' Credit Metrics Will Mend Slowly; Oil And Gas Firms Foresee Higher Demand

Chart 3

Key Risks And Trends

The major risk for the sector is slower demand growth for steel and raw materials from China. We expect China's demand growth for metals and minerals will be lower than its overall macroeconomic expansion, as the country gradually transitions to a consumption-led economic model. In India, in addition to moderate demand growth, internal factors such as a mining ban, delay in environmental clearances, and challenges with land acquisition are key risks for this country's metals and mining sector. Overcapacity will continue to plague the sector at least until the first half of 2014. Segments experiencing a severe glut are the aluminum, nickel, thermal coal, and coking coal industries. Meanwhile, merger and acquisition activities seem to be slowing on the back of a soft sector outlook.

Ask The Analyst

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Sector Review: Asia-Pacific Credit Trends 2014: Mining Companies' Credit Metrics Will Mend Slowly; Oil And Gas Firms Foresee Higher Demand

What's the profitability outlook for steel manufacturers in North Asia?

We don't expect steel prices and margins to recover strongly in 2014, although modest improvement and stabilization should occur during the period. Steelmakers in North Asia face persistently intense competition regionally and overcapacity, particularly in China. The mounting competition has spiked exports from China, Japan, and India. This trend might continue in 2014 because of slow demand recovery, significant overcapacity, robust production, and weaker local currencies. The only bright spot is lower raw material prices, in particular for coking coal. The price for coking coal has recently gone down to US$150/ton from almost US$300/ton in 2011.

What's the outlook for the iron ore sector?

We believe iron ore prices may continue to support miners' strong cash flows in the first half of 2014, with still robust demand from China and incremental increases in supply. However, we expect prices to trend downward in the medium term when new low-cost seaborne expansion from Australia and Brazil fully ramps up, and India resumes its iron ore exports. As such, Standard & Poor's price deck assumes an iron ore price (CIF China Fe62%) of US$110 per ton for calendar year 2014 and US$100 per ton for 2015, to calculate the expected credit metrics of rated companies. Given iron ore's significant contribution to earnings and cash flows to mining companies such as BHP Billiton Ltd., Rio Tinto PLC, and Fortescue Metals Group Ltd. (FMG), an unexpected significant decline in iron ore prices that coincides with heavy capital expenditure could worsen the credit quality of these companies. Mining majors such as Rio, BHP, and FMG have already cut costs substantially in light of the fall in prices. Moreover, productivity gains, cost cuts, and higher production volumes from their expansion projects should help to reduce their unit costs further. In our view, these initiatives should position major iron ore producers to weather a future downcycle after completion of their current round of expansion.

How are speculative-grade companies coping with lower commodity prices, particularly in terms of their liquidity levels and refinancing risk?
The subdued outlook for commodity prices could affect some companies' access to capital markets or reduce support from lenders. In fact, we took a number of negative rating actions in the past three months because of reducing liquidity levels and heightened refinancing risk for marginal miners. The ratings on Australia's Mirabela Nickel Ltd. were lowered to 'D' because of a missed interest payment recently. Meanwhile, Indonesian miner PT Bumi Resources Tbk.'s liquidity cushion has declined materially because cash flows have reduced as a result of lower prices and declining cash balances since early 2013. We believe the company still faces significant refinancing risk in 2014. Likewise, Mongolian Mining Corp. (MMC) was downgraded, to 'B-' in August 2013, because of the company's reduced liquidity cushion and refinancing risk. We expect MMC's liquidity sources will not cover its liquidity needs over the next 12 months, despite an improvement in operating cash flows and unless the company rolls over its promissory notes and refinances its bank loans. China's coal miner Hidili Industry International Development Ltd. is facing severe liquidity issues that will hamper its

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Sector Review: Asia-Pacific Credit Trends 2014: Mining Companies' Credit Metrics Will Mend Slowly; Oil And Gas Firms Foresee Higher Demand

ability to pay its high interest burden in the next 12 months. The negative outlook also reflects the company's limited options to repay its debt, and the possibility that it will be unable to roll over its short-term debt.

Oil And Gas Fortunes Will Rise And Fall In Line With Economic Conditions
Analysts: Lawrence Lu, Andrew Wong, Gloria Lu

Sector Outlook
The credit outlook for Asia-Pacific oil and gas companies will largely be stable for 2014. We think that refiners and marketers may face more challenges though, particularly in environments where price regulations exist. We don't project any startling developments for the sector in 2014, with most companies sticking to current business plans to keep their ratings stable at their respective levels (see table 2).
Table 2

Asia Pacific Oil And Gas Sector Outlook For 2014

Business conditions Business outlook Financial trends Sector outlook Satisfactory No change Same Stable

Key Risks And Trends

The sector's key risk is a slow global recovery or a recession that resulted in much lower demand, weaker prices, and reducing cash flows. Also posing risks are uncertain acquisition appetites and the financial discipline of oil companies, plus weaker profitability generally. Among the trends we've noticed are regional economic growth boosting energy demand, and an increase in the economic and political importance of the sector across the region. Elevated prices are supporting oil and gas companies' access to internal and external capital, while discretion in spending plans has been used amid an environment of weaker operating conditions all round.

Ask The Analyst

Has the investigation of CNPC's senior executives had an impact on CNPC's credit quality and, for that matter, China's oil and gas industry?
We believe that the investigation will have minimum impact on the daily operations of China National Petroleum Corp. (CNPC), because central government-owned enterprises like CNPC have tight supervision from the sole shareholder--the State Asset Supervision and Administration Commission. We expect CNPC to continue investing overseas, as China's reliance on import oil will continue to rise in line with its expanding economy--albeit likely at a slower pace than in the past. In our opinion, the growth momentum of China's

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Sector Review: Asia-Pacific Credit Trends 2014: Mining Companies' Credit Metrics Will Mend Slowly; Oil And Gas Firms Foresee Higher Demand

economy is unlikely to change in the next few years, and because scale is important for the oil companies to compete globally, the likelihood of the government breaking up such companies is remote in the near-to-medium term. That said, should the government open up the industry to allow more private capital participation, it would weaken the business risk profiles of China's three national oil companies, as it would undermine their current monopolistic positions in the domestic market.

What is Standard & Poor's view on the oil price and oil companies' spending plans?
While we routinely publish oil and natural gas price assumptions, we do not forecast oil and gas prices. We use the price assumptions for financial modeling to assess a company's credit quality and to compare credit quality among oil and gas companies. We have short-term (two-year) price deck assumptions that include a conservative discount for the hydrocarbon forward-price curves. The long-term price deck (three years and beyond) factors in supply and demand fundamentals and industry cost curves, among other factors. Typically, oil companies' spending plans are based on conservative price assumptions to evaluate the economics of a project through the cycle. Spending plans also consider future energy demand. We have seen oil and gas companies' spending plans spike by almost 80% since 2008. This increase is due to the size, complexity, and cost per barrel of oil of projects. We believe these spending plans will remain elevated, considering the growth in energy demand. However, these plans contain some discretion related to mergers and acquisitions, enabling companies to moderate expenditure should operating conditions deteriorate. That has been the case in the second half of 2013, with several companies (among them Petroliam Nasional Bhd. and PTT Public Co. Ltd.) announcing the deferral of expenditure in view of a weaker outlook for oil prices.

If the oil price declines sharply, the oil companies could face material impairment loss--how do you factor this in the rating analysis?
We view impairment losses as a balance-sheet impact only, and this does not directly affect our analysis. Instead, we look at the cash flow metrics and the impact of a sharp decline in oil prices on a company's cash flow coverage.

Related Research
Articles in the Asia-Pacific Credit Trends 2014 series: Transportation Infrastructure Faces Policy Uncertainty; Utilities Deal With High Energy Costs And Green Power, Dec. 4, 2013 Still Robust Domestic Growth and Steady Financial Profiles Underpin Our Mostly Stable Outlook On Indonesia's Corporate Sector, Oct. 30, 2013 Middle Classes Fuel Consumer Products; Retail To Keep Doing It Hard; Gaming On A Roll, Oct. 30, 2013 Real Estate Developers Wrestle With Regulatory Curbs; REITs Hunt For M&As, Oct. 29, 2013 Tech Firms Focusing On Asia And Smart Devices Will Outperform, Oct. 28, 2013 Telcos Look To The Cloud In Search Of Growth, Oct. 27, 2013
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client (as defined in Chapter 7 of the Corporations Act).

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