Fitch Ratings has affirmed China Three Gorges Corporation's (CTG) and subsidiary China Yangtze Power Co., Ltd.'s (CYPC) Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDRs) and senior unsecured ratings at 'A+'.

The Outlook is Stable.

CTG's ratings are equalised with China's sovereign rating (A+/Stable), based on our Government-Related Entities (GRE) Rating Criteria. This is due to the strong likelihood of CTG receiving state support given its strategic importance to China in terms of power supply, flood control, drought relief, navigational improvement and environmental protection as well as the consistent policy and financial support it receives from the state.

CYPC's ratings are equalised with those of its 55.51% parent, CTG, based on a 'High' strategic incentive, 'High' operational incentive and 'Medium' legal incentive for CTG to provide support, under our Parent and Subsidiary Linkage Rating Criteria.

A full list of rating actions is at the end of this rating action commentary.

Key Rating Drivers

'Very Strong' State Linkage: We assess CTG's status, ownership and control as 'Very Strong'. The company is a backbone state-owned enterprise (SOE) that is 90% owned by the central State-owned Assets Supervision and Administration Commission and 10% by the Social Security Fund. It has a policy mandate in clean-energy generation and environmental protection from China's top authorities.

We assess CTG's support record as 'Very Strong'. The construction of the Three Gorges hydropower project received government funding through sizeable equity injections via a fund that was financed by nationwide power tariffs. Intangible support includes mandates to build resource-rich and profitable hydropower stations in China. The support has been sufficient for CTG to maintain an investment-grade Standalone Credit Profile (SCP) in the 'bbb' category.

Strong Impact of Default: We assess the socio-political implications of a default by CTG as 'Strong', due to the political sensitivity of the Three Gorges project. CTG is China's leading hydropower producer and is crucial in environmental protection, flood control and drought relief. We assess the financial impact of a default as 'Very Strong', because CTG is an active domestic and global bond issuer and is regarded as the government's proxy borrower. A default would pose significant reputational risk for the state and limit funding access for other GREs.

Hydropower Output Recovering: Water flow along the Yangtze River started to recover in 2H23, after weakness in 2H22 and 1H23. Average water flow into the Three Gorges Reservoir was up by 56% yoy in August-November 2023. We expect the six major stations to generate 266.4 terawatt hours (TWh) in 2023, implying 25% yoy growth in 4Q23, supported by the stronger water flow and capacity expansion at Baihetan station. Water storage levels at station reservoirs has also risen, boding well for further generation recovery in 2024.

Rapid Expansion in Renewable Power: We expect renewable power to attract the highest investment and be the fastest expanding segment within CTG in the next few years after the full commissioning of the Baihetan hydropower station. China Three Gorges Renewables (Group) Co., Ltd, which owns around 80% of CTG's wind and solar capacity in China, has roughly doubled its capacity in the past three years. We expect further capacity expansion at around a 20% CAGR during 2023-2026. The company's power generation rose by 14.7% yoy to 28.1TWh in 1H23, of which 19.8TWh was from wind farms.

Low Return from Environmental Protection: We expect CTG to slow the expansion of its environmental protection section from 2023, given the lower return of environmental projects compared with its other businesses. This follows intensive investment in the past few years, with the segment's total assets ballooning to CNY80.0 billion in 2022, after rising by CNY24.5 billion in 2022 and CNY21.8 billion in 2021. Meanwhile, the segment's profit after tax declined to CNY483 million in 2022, from CNY1,113 million in the previous year, on lower investment income.

SCP Assessed at 'bbb': CTG has the strongest business profile among Fitch-rated Chinese power generation companies, supported by its globally significant scale, high asset quality, stable generation volume, competitive costs and low tariff volatility. However, EBITDA net leverage rose to 6.2x in 2022, from 5.9x in 2021, on weaker water flow. We expect gradual deleveraging towards 5.6x over the next four years, although this is subject to the company's capex and equity investment appetite.

CYPC Equalised with Parent: We assess the strategic incentive for CTG to support CYPC as 'High', as CYPC owns CTG's most important operational assets; the six major hydropower plants on the Yangtze River, with total generation capacity of 71.7 gigawatts (GW). We estimate that CYPC will contribute 57% of CTG's EBITDA in 2023, after the injection of the Wudongde and Baihetan stations.

The 'High' operational incentive to provide support reflects 'High' management overlap and strong group control, while we assess synergies at 'Medium'. The 'Medium' legal incentive reflects CTG's large public bonds with cross-default clauses covering CYPC. We expect CYPC's EBITDA net leverage to rise to 5.8x in 2023 (2022: 2.7x) after the acquisition of two major hydropower stations, before resuming deleveraging as a result of positive free cash flow.

Derivation Summary

Our 'Very Strong' assessment of CTG's status, ownership and control is the same as that of State Grid Corporation of China (SGCC, A+/Stable), while the assessment is 'Strong' for China Huadian Corporation Ltd. (A/Stable) and State Power Investment Corporation Limited (SPIC, A/Stable). CTG and SGCC are both categorised as type II commercial SOEs by the State-owned Assets Supervision and Administration Commission, with high strategic importance to the state, and therefore are subject to a higher degree of control by the government. In contrast, Huadian and SPIC are categorised as type I commercial entities, which are more commercially driven.

Our 'Very Strong' assessment of CTG's support record reflects the sufficient financial support it has received, government mandates to build and operate resource-rich hydropower stations and the resulting investment-grade SC. This compares with 'Strong' for Huadian and SPIC.

We assess the socio-political implications of a CTG default as 'Strong', reflecting the high political and reputational risk of a default, in line with Huadian and SPIC. The financial implications of a default are assessed as 'Very Strong', in line with the assessment for Huadian and SPIC. CTG is a large international and domestic borrower and is viewed by Fitch as a proxy government borrower, while a default by Huadian or SPIC may jeopardise financing access for the other big-five Chinese independent power producers in light of their significant combined debt exposure.

Key Assumptions

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

Power generation of the six major hydropower stations to slightly increase in 2023, as capacity expansion at the Baihetan station and water flow recovery in 2H23 compensate for weak output in 1H23

Power generation of major hydropower stations to increase by single-digits during 2024-2026, as water flow recovers

Average tariff of the main hydropower plants to marginally trend down due to more market-traded volume and lower market prices

Wind and solar power capacity to increase by 7.5GW a year on average during 2023-2026

Annual capex to stay in the range of CNY75 billion-90 billion in 2023-2026, with a downward trend

RATING SENSITIVITIES

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

CTG

Positive rating action on the Chinese sovereign, provided the likelihood of support from the government remains intact

CYPC

An upgrade of CTG's ratings, provided the likelihood of support from CTG remains intact

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

CTG

Negative rating action on the Chinese sovereign or a weakening of the likelihood of support from the government

CYPC

A downgrade of CTG's ratings or a weakened likelihood of support from CTG to CYPC.

For the sovereign rating of China, the following sensitivities were outlined by Fitch in its ratings action commentary of 31 August 2023:

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

Public Finances: A sustained upward trajectory in general government debt/GDP from persistently high fiscal deficits or a rise of contingent liabilities, for instance from LGFVs, such that debt levels compare less favourably with rated peers.

Macro: Reduced confidence in economic policymaking and medium-term growth prospects.

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 the official foreign-exchange reserves database (COFER).

Liquidity and Debt Structure

CTG had CNY46.1 billion in readily available cash on a consolidated basis at end-1H23, against total short-term debt of CNY89.2 billion. It also had CNY25.6 billion in tradable financial assets and large market positions in A-share stocks booked as associate companies. This boosted liquidity, as most of the financial assets were highly liquid. CTG also had undrawn banking facilities of CNY1,392 billion as of 1H23 and secure relationships with China's top-tier banks, such as China Development Bank (A+/Stable) and Bank of China Limited (A/Stable), supported by its central backbone SOE status. CTG also has solid access to domestic and international bond markets.

CYPC had short-term debt of CNY103.0 billion and readily available cash of CNY13.1 billion at end-June 2023. The company has strong access to bank financing as well as bond markets. It had undrawn banking facilities of CNY162.4 billion as of 1Q23 and owns a large portfolio of highly liquid utility SOE stocks.

Issuer Profile

CTG is the world's largest hydropower producer. It owned more than 124.7GW in power generation capacity as of 2022. CTG also operates wind and solar power assets and is committed to environmental projects, mainly along the Yangtze River.

CYPC is CTG's flagship listed subsidiary, holding the parent's most important hydropower assets. It is the parent's largest revenue and cash flow contributor.

Summary of Financial Adjustments

Fitch adjusted CTG's readily available cash at end-2022 by giving 100% cash benefit to its CNY273 million reverse purchase of China treasury bonds and CNY5.6 billion of wealth-management products. These products are from China's large SOEs and policy banks, and have short-term maturities and fixed returns.

CTG received a CNY1.3 billion maintenance subsidy of public service facilities in 2022. However, the company says that it paid the government an extra CNY1.3 billion dividend in 2021, which was then returned to CTG as a subsidy. As such, we adjust both dividend payment and operating EBITDA down by CNY1.3 billion.

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

CTG's ratings are equalised with those of the China sovereign. CYPC's ratings are equalised with those of

CTG.

ESG Considerations

The highest level of ESG credit relevance is a score of '3', unless otherwise disclosed in this section. A score of '3' 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. Fitch's ESG Relevance Scores are not inputs in the rating process; they are an observation on the relevance and materiality of ESG factors in the rating decision. For more information on Fitch's ESG Relevance Scores, visit https://www.fitchratings.com/topics/esg/products#esg-relevance-scores.

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