RPT-Fitch revises Delong's outlook to stable; affirms ratings
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Aug 28 (Reuters) - (The following statement was released by the rating agency)
Fitch Ratings has revised China-based steel company Delong Holdings Limited's (Delong) Outlook to Stable from Negative. Its Long-Term Issuer Default Rating (IDR) has been affirmed at 'B'. Fitch has also assigned Delong a senior unsecured rating of 'B'.
The Outlook has been revised to Stable following the release of its H113 results, which showed Delong having the ability to generate positive free cash flow (FCF) even under a sustained difficult operating environment.
KEY RATING DRIVERS
Neutral FCF for H113: Under a difficult operating environment in H113, Delong's net debt position only rose CNY10m after taking into account the CNY260m investment in financial assets. This was even despite the fact that its H113 EBITDA of CNY362m was only 38% of what it achieved in 2012 and that its gross profit for metal fell to CNY127/ton in H113 from CNY196/ton in 2012. This was largely a result of a stronger iron ore cost versus steel selling prices in 2013.
Moderate leverage sustainable: Delong generated CNY130m positive FCF and its funds flow from operations (FFO) net leverage declined to 1.94x in 2012 from 4.33x in 2011, even after paying an estimated CNY396m (including bank loans) to acquire Aoyu. Delong's average FCF over the past five years was minus CNY5.8m. This means that Delong's capex and acquisition of CNY1,648m over the past five years had been mostly funded by internally generated operating cash flow. The large negative FCF of CNY901m in 2011, leading to a significant deterioration in its leverage, was a result of working capital fluctuations.
Since its listing in 2005, Delong has maintained a conservative FFO net leverage of 2.4x through its capacity expansion cycle, which saw its production capacity grow to 3.8 million tons per annum (mtpa) at end-H113 from 1.4mtpa in 2005. Net debt peaked at CNY2.1bn in 2008 before falling to CNY1.98bn at end-H113 despite the company having spent CNY1bn in capex and acquisition, and added financial assets amounting to CNY427m since 2008.
Weak industry fundamentals: Delong continues to face a difficult operating environment over the medium term, in the face of intense competitive pressure, persistent over-capacity and limited influence on raw material costs. Any steel price improvement quickly pushes steel producers to increase production and eventually leads to rising iron ore prices. Small Chinese steel producers are keen to produce at full capacity to defray their fixed costs, thus resulting in disorderly competition within the industry. This is not likely to change in the medium term since there are few steel companies that have the financial resources to consolidate the industry.
It is Fitch's view that any improvements of industry fundamentals are more likely to come from an iron ore supply glut than a strong surge in demand for steel as China moves away from an investment-led economic growth model. Small scale limits operations: Delong's ratings are constrained by its small operating scale, with a total production capacity of 3.8 mtpa. This restricts its product range and limits its differentiation among a field of over 40 other similarly sized steel companies in Hebei Province, where Delong is based.
Expansion uncertainty constrains ratings: Delong's current capacity is still far from its 8mtpa target, which Fitch believes would be achieved largely through the acquisition of additional local steel mills. This strategy will inevitably increase debt but may not repeat the same substantial synergies seen in the Aoyu acquisition.
Negative: Future developments that may, individually or collectively, lead to negative rating action include:
- deterioration of annual metal margin below CNY200 per ton
- FFO fixed charge cover remaining below 2.5x (4.3x in 2012)
- FFO net leverage above 3x on a sustained basis
- negative FCF
Positive: Future developments that may, collectively, lead to positive rating action include:
- increasing crude steel capacity beyond 5mtpa
- maintaining FFO net leverage below 2.0x
- remaining FCF positive