RPT-Fitch Revises ZTE's Outlook to Positive, Affirms at 'B+'
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Feb 21 (Reuters) - (The following statement was released by the rating agency)
Fitch Ratings has revised China-based ZTE Corporation's (ZTE) Outlook to Positive from Stable. The agency has affirmed the telecommunications equipment provider's Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDR) at 'B+'.
KEY RATING DRIVERS
Recovery to Continue: The revision in the Outlook reflects Fitch's expectation of a reversal of the decline in ZTE's credit profile, driven by China's 4G network rollout and the company's strategic refocus and cost reductions. However, the ratings are constrained by high financial leverage, the highly competitive global telecoms equipment market, which is characterised by cyclical demand, ZTE's weaker position in Europe, its smaller 4G market share in developed markets, its over-dependence on China, and increasing competition in the smartphone industry.
China's 4G Investment: China's 4G rollout will provide ZTE an opportunity to repair its credit profile and deleverage. We expect China to account for over 60% of ZTE's network revenue in the next two years. The Chinese government awarded the time division long-term evolution licences to all three Chinese telecoms operators in December 2013, which we expect to drive a modest growth in Chinese telecoms capex in 2014. We expect licensing of frequency division duplex long-term evolution technology in next 12 months to fuel operators' capex in 2015.
Network Division Driving Margins: Fitch expects further margin improvement within the network division in the next 12-18 months, driven by more China contracts and the completion of low-margin European modernisation contracts. Network gross margin rebounded to 32.4% in 1H13, from 26.5% in 2012. However, we do not expect ZTE's margins to recover to historical highs as the smartphone division will weigh on overall margins. We believe ZTE may need to reduce its over-dependence on Chinese telecoms capex before the current cycle peaks to maintain the recovery in its margins.
Smartphone Challenges: Fitch believes that rapid commoditisation of smartphones, saturation in developed markets and Lenovo's new access to North and Latin American markets through its Motorola acquisition will present a significant challenge to ZTE's smartphone ambitions in those markets. Also ZTE's smartphones are struggling domestically - market share contracted to 5.4% in 3Q13 from 9.7% in 3Q12, according to iiMedia Research. Gross profit of ZTE's terminal segment fell 19% yoy in 1H13. Meaningful smartphone contribution looks unlikely in next two years.
High Leverage: Improving cash flow from operations supported ZTE's debt repayment in 2013, but funds flow from operations (FFO)-adjusted leverage will remain above 6x in the short term. A significant deleveraging to pre-2010 levels (2009: 4.1x, 2010: 5.0x) is likely to take a few years and require a full recovery in operating EBIT margin, including VAT refunds, to over 6% (2012: -1.9%). At end-June 2013, including bank advances on factored trade receivables of CNY8bn, ZTE had gross debt of CNY35.5bn.
Adequate Liquidity: ZTE's liquidity remains satisfactory. Unrestricted cash of CNY16bn at end-June 2013 exceeds the CNY13bn of short-term loans and the current portion of long-term debt. The company is well supported by Chinese banks. Unused banking facilities totalled CNY48bn at end-June 2013. In addition, we expect positive free cash flow in 2H13 and 2014.
Negative: Future developments that may, individually or collectively, lead to negative rating action include:
- sustained operating EBIT loss (including VAT refunds)
- sustained FFO-adjusted leverage above 6x
- sustained FFO-adjusted net leverage above 4x
Positive: Future developments that may, individually or collectively, lead to positive rating action include:
- sustained operating EBIT margin (including VAT refunds) of 5% or above
- sustained FFO-adjusted leverage below 5x
- sustained FFO-adjusted net leverage below 3x
- sustained positive CFO generation.
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