HONG KONG, August 30 2019. Pengyuan International has downgraded China Hongqiao Group Limited’s (Hongqiao)’s global scale long-term issuer credit rating (ICR) to ‘BB-’ from ‘BB’. The rating outlook is revised to negative. 


Hongqiao’s rating has been downgraded to reflect the Company’s shrinking cash, increased capital expenditure and higher working capital requirements, which have led to higher leverage and lower liquidity in the first half of 2019. 


The negative outlook reflects Pengyuan International’s view that the Company’s financial profile may continue to deteriorate and China’s aluminium consumption will remain weak, over the next 12 months, as a result of soft automobile sales and slower property sales growth.


KEY RATING RATIONALES 


Credit Weaknesses

Higher working capital requirements. Hongqiao reported a negative operating cash flow in the first half of 2019, which was caused by higher working capital requirements. Due to the difficult operating environment, the Company’s receivable days have increased to 38 and 18 in the first half 2019 and 2018 from 5 in 2017. Its inventory days have increased to 113 and 86 in the first half 2019 and 2018 from 73 in 2017. We expect the Company’s working capital requirements to remain high in 2020 due to the challenging funding environment. 


Increased leverage. Hongqiao’s cash has fallen by 43% to RMB26 billion in the first half of 2019 from RMB45 billion at the end of 2018 due to the increase of acquisitions, capital expenditure and operating cash outflow. Though the Company’s gross debt decreased by 5%, its adjusted debt has increased by 36% to RMB54 billion from RMB40 billion at the end of 2018. As a result, Hongqiao’s leverage as measured by Debt to EBITDA increased to 2.9x in the first half of 2019 from 2.2x at the end of 2018, by our estimate. We expect the Company’s Debt to EBITDA to increase to 3.8x by the end of 2019 and will remain around 3.5-4.0x in 2020 and 2021. 


Deteriorating liquidity. Due to its weaker cash position, Hongqiao’s liquidity has deteriorated in the first half of 2019. The Company reported cash of RMB26 billion in contrast to its short-term debt of RMB27 billion at the end of half 2019. By our estimate, Hongqiao’s cash flow liquidity ratio decreased to 1.1x in the first half of 2019 from 1.5x in 2018. In our view, a tighter liquidity amid the tough financing and operating environment will put pressure on Hongqiao’s financials in 2019 and 2020. 


Declined revenue. Hongqiao’s revenue declined by another 7% in the first half 2019 following the 8% decline in 2018. Aluminium products, Hongqiao’s core business, has seen 11% decline in revenue, driven by 14% decline in sales volume, which was caused by the government’s production control and the Company’s capacity upgrade. We expect the Company’s revenue to decline 7% in 2019 but to pick up and grow at a rate in low single digit range in 2020 and 2021. In our view, the oversupply and weak consumption will continue to constrain the recoveries in China aluminium industry in 2019-2020. In the first half of 2019, the growth of China’s primary aluminium consumption slowed to 0.8% from 4.7% in 2018.

 

Credit Strengths

Leading market position maintained. In 2018, Hongqiao remains the largest market aluminium producer in the world as measured by production volume, despite the Company’s capacity reduction in late 2017. We estimate Hongqiao has annual production capacity of 13 million tonnes of alumina, 6.5 million tonnes of aluminium products, and 500,000 tonnes of aluminium fabrication at the end of 2018.

 

Integrated operation offered benefits. Thanks to its integrated operation, Hongqiao consistently reports higher profitability than its peers.  The Company managed to outperform the industry in 2018, by reporting a 5% year-on-year growth in profit, compared to the China aluminium industry’s profit decline of 40%. Thanks to lower raw material prices and cost efficiencies, Hongqiao’s EBITDA margin has improved slightly to 23% in the first half of 2019 from 21% in 2018, by our estimate.

 

 

RATING OUTLOOK

The negative outlook reflects Pengyuan International’s view that the Company’s financial profile may continue to deteriorate and China’s aluminium consumption will remain weak, over the next 12 months, as a result of soft automobile sales and slower property sales growth.


We would consider downgrading Hongqiao’s issuer credit rating if its credit profile deteriorates substantially, which could be caused by 1) Debt to EBITDA increases to above 3.7x with little prospects to recover; 2) EBITDA to interest coverage decreases to below 3x; 3) substantial deterioration of liquidity condition; and 4) significant deterioration of its operational strength.


We would consider to remove the negative outlook if its credit profile improves noticeably, which could be caused by 1) the stabilizing of financial profile; 2) improvement of its operational strength; 3) ease of the liquidity pressure.

 

Note: ratings mentioned above are unsolicited.

 

ANALYSTS CONTACT

MEDIA CONTACT

OTHER ENQUIRIES

Primary Analyst

Winnie Guo

+852 3615 8344

winnie.guo@pyrating.com

 

Secondary Analyst

Simon Lee

+852 3615 8307

simon.lee@pyrating.com

 

Committee Chair

Tony Tang

+852 3615 8278

tony.tang@pyrating.com

 

media@pyrating.com

contact@pyrating.com

 

Date of Relevant Rating Committee: 29 August 2019

Additional information is available on www.pyrating.com

Related Criteria

General Corporate Rating Criteria (15 March 2019)

Corporate Financial Adjustments and Ratio Definitions (7 May 2019)


 

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