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Rating Action:

Moody's assigns first-time Baa1 rating to Sinochem Hong Kong

26 Oct 2010

Hong Kong, October 26, 2010 -- Moody's Investors Service has assigned a first-time Baa1 issuer rating to Sinochem Hong Kong (Group) Company Limited ("Sinochem HK").

At the same time, Moody's has assigned a provisional (P)Baa1 senior unsecured rating to Sinochem Overseas Capital Company Ltd's proposed USD guaranteed senior notes issuance.

The notes will be unconditionally and irrevocably guaranteed by Sinochem HK.

The outlook for the ratings is stable.

This is the first-time Moody's has assigned ratings to Sinochem HK.

Moody's expects to remove the senior notes rating from its provisional status upon completion of the issuance.

The proceeds from the proposed issuance will be used for working capital, refinancing of short term loans, capital expenditures and other general corporate purposes.

Rating Rationale:

Sinochem HK's Baa1 rating reflects a credit profile that benefits substantially from indirect government ownership. On a standalone basis, the company's fundamental credit profile (BCA) is equivalent to a Ba2.

However, its final Baa1 rating incorporates the impact of the high level of support that Moody's believes the Chinese government would provide, through Sinochem Group -- Sinochem HK's 98% ultimate parent -- in the event extraordinary financial support is required.

"Such an expected high level of support reflects Sinochem HK's dominant position in China's fertilizer industry, particularly in potash imports, and the industry's importance to Chinese agriculture and food security," says Ivan Chung, a Moody's Vice President and Senior Analyst.

"Furthermore, the company's long-established and steadily growing oil trading activities -- along with its expanding E&P business -- are raising its level of importance to China's energy sector," says Chung.

In terms of its specific role, Sinochem HK is responsible for executing and holding a majority of the strategically important overseas assets of Sinochem Group.

As its parent, Sinochem Group has a history of providing it with new capital, inter-company loans, loan guarantees and letters of comfort to assist its development and financial management.

Underlining the importance of Sinochem Group -- and, in turn, the strong likelihood of government support for Sinochem HK -- is the fact that the parent is considered as one of the 23 "backbone state-owned enterprises" owned by China's State Council via the State Assets Supervision and Administration Commission ("SASAC").

"The standalone Ba2 rating reflects Sinochem HK's diversified business operations in important and growing sectors in China -- namely, fertilizers, oil & gas, and property. While the underlying cyclicality of these core businesses means that their respective earnings contributions may vary over a particular year, each has contributed an average of about 20% - 30% of gross profit in the last 3 years," says Chung.

Sinochem HK's position in fertilizers is important strategically to the country in the context of food security, and the company has established extensive domestic and international sourcing and distribution networks for its fertilizers, which cover over 90% of arable land in China. It also has long-term relationships with global oil suppliers, and domestic and international customers

As China has a heavy reliance on imported crude oil and potash, such established relationships and distribution networks mean that Sinochem HK can benefit from the growth in demand for these commodities.

"Furthermore, recurrent revenue from the high quality investment properties and profits from commercial properties development activities under its listed subsidiary, Franshion Properties, offer some degree of revenue diversification," Chung says.

But such strengths are counterbalanced by: 1) the inherent volatilities in its fertilizer and oil & gas trading businesses; these high volume and thin-margin activities represent a high business risk profile: 2) the company's acquisitive strategy and continuing overseas expansion, including the recent USD 3.07 billion acquisition of a 40% interest in Peregrino, an offshore oilfield in Brazil; and 3) its weak credit metrics and high financial leverage.

Sinochem HK's projected adjusted debt to capital of about 50%-55% and FFO/Debt of about 10% in the next 2-3 years are on the weak side for its Ba2 standalone rating, given the industry sectors in which it operates.

Moody's also notes the company has been progressively expanding into upstream oil & gas E&P activities as well as fertilizer production.

"While the execution risk of its E&P project is partly mitigated by the participation of a strong partner -- Statoil (senior unsecured rating Aa2) -- and the company's cumulative execution experiences since 2002, the project entails a huge investment risk, and exposes it to exogenous uncertainties," says Chung. "As such, execution risk remains a constraint for its standalone rating."

The stable outlook reflects Moody's expectation that the company will maintain its strategically important role in the Sinochem Group and China's fertilizer and agricultural sectors .

The rating could undergo a downgrade if Sinochem HK's standalone credit profile deteriorated, most likely due to: 1) its failure to execute its business plan, such that cash flow generation is weaker than anticipated; 2) it reports large trading losses in its fertilizer and oil trading businesses; or 3) it undertakes large scale debt-funded mergers and acquisitions.

In terms of financial metrics, Moody's would regard the following as signals for downward rating pressure: 1) adjusted debt/capitalization consistently above 60%; 2). EBITDA interest coverage below 3x; or 3). FFO/debt below 8%-10 % on a consistent basis

Furthermore, the rating would be under pressure if there is evidence of a weakening in support from the Chinese government, via Sinochem Group, or a change in its business model to pursue non-core businesses, which reduce its strategic importance to the Chinese economy.

Upward rating pressure is limited in the near to medium term, given the relatively weak nature of the company's financial profile and the ongoing evolution of its businesses. But the rating could be upgraded over time if Sinochem HK's BCA improves. This could be a result of: 1) establishing a track record of stable profitability and cash flow; 2) achieving planned sales growth targets in E&P and improving its overall profit margins; or 3) materially de-leveraging on a consistent basis.

Moody's would also regard the following as signals for upward rating pressure: 1) adjusted debt/capitalization below 40%; 2) EBITDA interest coverage above 7.5x; or 3 FFO/Debt above 25%-30% on a consistent basis.

Sinochem HK's ratings were assigned by evaluating factors Moody's believes are relevant to the credit profile of the issuer, such as i) the business risk and competitive position of the company versus others within its industry, ii) the capital structure and financial risk of the company, iii) the projected performance of the company over the near to intermediate term, and iv) management's track record and tolerance for risk.

These attributes were compared against other issuers both within and outside of Sinochem HK's core industries and Sinochem HK's ratings are believed to be comparable to those of other issuers of similar credit risk.

Sinochem HK is 98% owned by Sinochem Group and holds a majority of its parent's important assets, including overseas E&P assets, and majority interests in listed fertilizer company, Sinofert Holdings Limited, and listed real estate company, Franshion Properties (China) Limited. It acts as a primary treasury center for the financing of Sinochem Group's overseas businesses and activities. It accounted for approximately 61% of Sinochem Group's total assets at the end of 2009 and 78% of its revenue for the year ended December 31, 2009.

Sinochem Group is a central government-owned SOE ("CGSOE"), and is directly owned and supervised by State-Owned Assets Supervision and Administration Commission ("SASAC") of China's State Council. It engages in agricultural, chemicals, energy, real estate and finance businesses. Sinochem is also one of 16 CGSOE that have approval from SASAC to perform real estate business. In 2009, its total revenue was RMB 243 billion and net profit was RMB 5.2 billion. Its total assets amounted to RMB 172 billion.

REGULATORY DISCLOSURES

Information sources used to prepare the credit rating are the following: parties involved in the ratings, parties not involved in the ratings, public information, confidential and proprietary Moody's Investors Service's information.

Moody's Investors Service considers the quality of information available on the issuer or obligation satisfactory for the purposes of assigning a credit rating.

MOODY'S adopts all necessary measures so that the information it uses in assigning a credit rating is of sufficient quality and from sources MOODY'S considers to be reliable including, when appropriate, independent third-party sources. However, MOODY'S is not an auditor and cannot in every instance independently verify or validate information received in the rating process.

Please see ratings tab on the issuer/entity page on Moodys.com for the last rating action and the rating history.

The date on which some Credit Ratings were first released goes back to a time before Moody's Investors Service's Credit Ratings were fully digitized and accurate data may not be available. Consequently, Moody's Investors Service provides a date that it believes is the most reliable and accurate based on the information that is available to it. Please see the ratings disclosure page on our website www.moodys.com for further information.

Please see the Credit Policy page on Moodys.com for the methodologies used in determining ratings, further information on the meaning of each rating category and the definition of default and recovery.

Hong Kong
Ivan Chung
Vice President - Senior Analyst
Corporate Finance Group
Moody's Investors Service Hong Kong Ltd.
JOURNALISTS: (852) 3758 -1350
SUBSCRIBERS: (852) 3551-3077

Hong Kong
Gary Lau
MD - Corporate Finance
Corporate Finance Group
Moody's Investors Service Hong Kong Ltd.
JOURNALISTS: (852) 3758 -1350
SUBSCRIBERS: (852) 3551-3077

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Moody's assigns first-time Baa1 rating to Sinochem Hong Kong
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