(The following statement was released by the rating agency)
Oct 25 -
Summary analysis -- China Automation Group Ltd. ------------------- 25-Oct-2012
CREDIT RATING: BB-/Negative/-- Country: China
Credit Rating History:
Local currency Foreign currency
06-Apr-2011 BB-/-- BB-/--
The rating on China Automation Group Ltd., a China-based industrial safety and critical control systems provider, reflects the uncertainty over the prospects for China's railway industry, the company's limited revenue base, and its high customer concentration. In addition, China Automation's technology base is weaker than leading global peers'. The company's dominant position in its niche petrochemical and railway control systems market in China tempers these weaknesses. The high entry barriers to these industries in China offer additional rating support.
China Automation's business risk profile is "weak," in our view. This is because our outlook for the railway industry remains uncertain, despite some signs of recovery in the past few months. Following a major train accident at Wenzhou in July 2011, the government put the bidding for many new projects on hold. In addition, many national railway projects were either suspended, slowed down, or delayed. These events significantly affected China Automation because the railway segment accounted for about half of the company's total revenues in the past two years. Revenues from signaling systems declined 51.6% to Chinese renminbi (RMB) 144.9 million because of the accident, and China Automation's net profit for the first six month of 2012 dropped 28% year over year, as we expected.
We anticipate that the company's profitability will remain under pressure during the rest of the year as well. The National Development and Reform Commission recently approved several infrastructure projects including rail projects, which could have some positive effects on China Automation's performance.
We believe China Automation will continue to face delays in payments from its clients, particularly the Ministry of Railways, over the next few quarters. The company's liquidity position could weaken unless it effectively manages its working capital. Similarly, China Automation's leverage could increase if the company takes on a significant amount of debt to meet potentially rising working capital needs. However, we expect the company's excess cash and internal cash flows from its petrochemical business to moderate the likely increase in debt.
China Automation's acquisition of Wuzhong Instrument Co. Ltd. will enhance the company's product mix and expand its revenue base. However, the company still has a limited client base. Despite China Automation's long relationships with its clients, any change in government policy that delays or cuts back project planning will hurt its operating performance.
China Automation lacks key hardware technology for more advanced automation systems. The company has a satisfactory technology base, particularly in software and system integration, in the domestic market. We expect China Automation to continue to expand through strategic alliances with foreign peers.
We expect China Automation to maintain its leading market position in safety and critical control systems in the petrochemical and railway industries due to the industries' high entry barriers. The high specialization required to develop petrochemical safety and control systems, high switching costs, and China Automation's proven record create the high entry barriers. The government's license and certification requirements for the supply of railway signaling and safety systems also deter potential new entrants. The company's order backlog at the end of June 2012 is about RMB2.1 billion, of which 60% is from the petrochemical segment and 40% from the railway segment.
China Automation's financial risk profile is "aggressive," in our opinion. The company's leverage has increased over the past year. Leverage could increase further in the next 12 months if China Automation uses debt to fund potentially higher working capital needs. According to our base-case scenario, the company's ratio of total debt to EBITDA is likely to weaken to 3.6x-4.2x in 2012, from 3.6x in 2011.
China Automation's liquidity is "adequate," as defined in our criteria. We expect the company's sources of liquidity to cover its uses by more than 1.2x in the next 12 months. Our assessment of liquidity is based on the following factors and assumptions:
-- China Automation's sources of liquidity include cash and funds from operations.
-- As of June 30, 2012, the company has cash and cash equivalents of about RMB548 million and short-term debt of about RMB334 million.
-- The company's uses of liquidity include planned capital expenditure, working capital needs, debt repayments, and dividend distribution.
-- We expect net sources to remain positive even if EBITDA declines by 15%.
China Automation has uncommitted bank facilities from several banks. The company's outstanding debts do not have financial covenants.
The negative outlook reflects the uncertainty surrounding a timely execution of the government's railway investment plan over the next 12 months. The outlook also reflects our view that China Automation's debt could increase or that its liquidity position could weaken due to higher working capital needs.
We could lower the rating if China Automation fails to maintain its profitability and leverage. A ratio of total debt to EBITDA consistently above 4x would indicate such weakening. This could happen if the execution of railway investments continues to be delayed or the company takes on significant debt to fund its increasing working capital.
We could revise the outlook to stable if China Automation maintains its profitability and leverage. A ratio of total debt to EBITDA consistently below 4x would indicate such stability. This could happen if: (1) railway investments progress in a meaningful and timely manner over the next 12-18 months; and (2) the company does not significantly increase its debt to fund working capital.