RPT-Fitch Downgrades China Oriental to 'BB'; Outlook Stable
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March 28 (Reuters) - (The following statement was released by the rating agency)
Fitch Ratings has downgraded the leading Chinese section steel producer China Oriental Group Company Limited's (China Oriental) Long-Term Issuer Default Rating (IDR) and senior unsecured ratings to 'BB' from 'BB+' with Stable Outlook.
Key Rating Drivers:
Weakened Financial Profile: China Oriental's rating downgrade is a result of a sustained deterioration of its financial profile due to a poor operating environment. At the same time, a portion of its capital is tied up in the development of new businesses. China Oriental's 2012 normalised working capital adjusted net debt/EBITDAR has risen to 3.1x from 1.6x in 2011, breaching the 2.0x single year guideline. Given the company's commitment in diversifying its business, its weakened financial metrics will not likely reverse even when the steel business environment stabilises.
Persistently Weak Operating Environment: We believe Chinese long steel products are facing a persistent over-production problem. Chinese steel producers are still making more long products at a point where China's rebalancing economy is switching to a more consumption-driven structure that favours flat steel product producers. The demand surge as a result of the 2009 government stimulus had directed capacity towards long products and this cannot be adjusted quickly. The most affected of China Oriental's products are H-section steel, billets and rebar that contributed to 54% of China Oriental's steel production revenue.
Non-steel Businesses Need Capital: China Oriental has secured land parcels in Suzhou for CNY314m in Dec 2012, indicating its decision to stay committed to its residential property development operation. The company has also provided loans of CNY380m to third parties. While we recognise that these operations are contributing to the company earnings, they nevertheless absorb over CNY700m of capital. In past downturns, China Oriental had quickly reduced its balance sheet to keep itself financially strong. With the new businesses, it has less financial flexibility to do so.
Product Leadership Supports Ratings: China Oriental's ratings are still supported by its leadership position in the section steel product. Despite the poorer performance, section steel remains the most profitable steel product contributing to 48% of its gross profit and generated the highest per ton gross profit of CNY170 versus the company's average of CNY99.
ArcelorMittal Assistance Benefits Operations: The company's ratings are also supported by the operational support from the world's largest steelmaker, ArcelorMittal S.A. (ArcelorMittal, BBB/Negative), which continues to render technical assistance to China Oriental. Fitch expects ArcelorMittal to remain committed to the Chinese steel market and China Oriental is one of its key integrated steel manufacturing investments in China.
Negative: Future developments that may, individually or collectively, lead to negative rating action include:
- leverage as measured by normalised working capital adjusted net debt/EBITDAR above 2.5x for two consecutive years or above 3.0x in any single year
- significant weakening of China Oriental's strategic and operational ties with ArcelorMittal, one of its major shareholders
Positive: Future developments that may, individually or collectively, lead to positive rating action include:
- leverage as measured by normalised working capital adjusted net debt/EBITDAR below 1.5x on a sustained basis
- no further working capital increases without a corresponding increase in revenue
- no material increases in noncore businesses
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