October 19, 2017 / 10:27 AM / a year ago

Correction: Fitch Assigns 'B+(EXP)' to China Grand Auto's Proposed Senior Perpetual Securities

(The following statement was released by the rating agency) HONG KONG, October 19 (Fitch) This is a correction of a release published on 19 October 2017. It corrects the shareholding details of Baoxin Auto Finance I Limited. Fitch Ratings has assigned Baoxin Auto Finance I Limited's (Baoxin Finance) proposed US dollar-denominated senior perpetual securities a 'B+(EXP)' rating and Recovery Rating of 'RR4'. Baoxin Finance is wholly owned by China Grand Automotive Services Co., Ltd (China Grand Auto; BB-/Stable). The securities will be unconditionally and irrevocably guaranteed by China Grand Auto. Fitch expects to accord no equity credit to the proposed securities in its evaluation of China Grand Auto's capital structure and leverage as this instrument ranks pari passu with the company's senior unsecured obligations. The final rating and assessment of equity credit are contingent upon the receipt of final documents conforming to information already received. The proposed perpetual securities are rated one notch below China Grand Auto's 'BB-' senior unsecured rating in accordance with Fitch's "Treatment and Notching of Hybrids in Non-Financial Corporate and REIT Credit Analysis" criteria. The one-notch difference reflects the proposed securities' coupon deferral feature. KEY RATING DRIVERS Large Scale, Strong Market Position: China Grand Auto's ratings are supported by its large operating scale and strong business profile. China Grand Auto is the largest auto dealership in China, with more than 750 outlets in 28 provinces covering more than 50 brands. China Grand Auto has been consolidating its position and the recent acquisition of Baoxin Auto has expanded the company's offerings in the luxury car segment. China Grand Auto is now the leading dealer in China for most of the major luxury brands including Audi, BMW, Volvo and Jaguar Land Rover. China Grand Auto's strong brand and geographical diversification mitigate the impact of product launch cycles and reduce earnings volatility. In addition, the company's large operating scale allows it to use its store network more efficiently to develop new revenue sources, such as commission income, leasing, and used car sales. Robust Long-Term Demand Prospects: China became the world's largest passenger vehicle market in 2013. Despite slower growth prospects, the long-term growth drivers for passenger vehicles remain intact due to low vehicle ownership penetration and density. On a medium-term (about five years) view, Fitch expects passenger-vehicle sales to grow at a mid-single digit percentage, which remains healthy and higher than the developed-market average. Contribution from Other Segments: In addition to a solid outlook for new car sales, Fitch expects increasing revenue contribution from other segments, including after-sales services, commission income, leasing and used car sales. Used car sales remain at a nascent stage in China, but have substantial growth potential in the next five to 10 years on the back of increasing car ownership, changing consumer behaviour and favourable policies. In 1H17, China Grand Auto saw a noticeable improvement in margins in its maintenance and commission segments as commissions doubled to CNY2.1 billion yoy. Competitive Industry, Low Bargaining Power: China's auto dealership industry is highly fragmented and competitive. Although China Grand Auto is China's largest dealership, it only has 3%-4% market share by sales volume across the country. Industry margins are low as bargaining power with suppliers is weak and the regulatory environment favours automakers over dealers. Chinese auto dealers generally have mid-single digit EBITDA margins, comparable with US peers. However, Fitch does not expect dealer margins to substantially deteriorate from current levels as automakers and dealers are dependent on each other and it is not in the automakers' best interests to continuously squeeze their dealers. High Leverage Constrains Ratings: CGA's financial leverage is relatively high after acquiring Baoxin, with FFO adjusted net leverage of 6.2x and net debt to EBITDAR of 5.4x at the end of 2016. Fitch expects leverage to improve gradually with better margins and limited capex requirements. Fitch expects FFO adjusted net leverage to improve to 4.8x in 2017 and to stay below 5.0x in the next few years, the level at which Fitch would consider negative rating action. China Grand Auto has received regulatory approval for an equity placement plan to raise up to CNY8 billion, which has not been completed. Fitch estimates that FFO net leverage may drop to a healthier level of under 4.0x if the equity placement is successful. However, if the equity proceeds are used for acquisitions and/or growth in the leasing business, the improvement in the leverage may not be as significant. Leasing Subsidiary Deconsolidated: China Grand Auto carries out auto leasing services via its leasing subsidiary, Huitong Xincheng. We have deconsolidated Huitong Xincheng for the purposes of our analysis in accordance with the Corporate Rating criteria. Huitong Xincheng had a debt-to-equity ratio of about 2.0x at the end of 2016, which we see as healthy. DERIVATION SUMMARY China Grand Auto's ratings are supported by its leading market position, large operating scale and strong business profile, but constrained by its relatively high leverage and low margins. Compared with PT Mitra Pinasthika Mustika Tbk (MPM; BB-/Stable), a motorcycle dealership in Indonesia which holds the master distributorship for Honda motorcycles, China Grand Auto has a much larger scale and a more diversified brand and geographical footprint, but higher leverage and slightly lower EBITDA margins. Compared with Chinese car rental companies such as eHi Car Services Limited (BB-/Negative) and CAR Inc. (BB-/Stable), China Grand Auto has higher leverage and lower margins, but this is mitigated by its much larger operating scale, limited capex requirements and a more stable competitive environment for the industry. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer (excluding leasing) include: - Low- to mid-single digit revenue growth in 2017-2020 - EBITDA margins of 5%-6% - Maintenance capex at 1.2% of revenue and CNY3 billion per year on acquisitions - 30% dividend payout ratio RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to Positive Rating Action - FFO adjusted net leverage (excluding leasing) sustained below 3.5x Future Developments That May, Individually or Collectively, Lead to Negative Rating Action - Sustained decline in market share and/or revenue - FFO adjusted net leverage (excluding leasing) sustained above 5x (2017 estimate: 4.8x) - FFO fixed charge cover sustained below 2x (2017 estimate: 2.4x) - EBITDA margin sustained below 3.5% (2017 estimate: 5.6%) LIQUIDITY Sufficient Liquidity: At the end of 2016, China Grand Auto had CNY45.6 billion of debt (excluding its leasing business), of which CNY24.8 billion was due within 12 months. This was covered by unused banking facilities and CNY11.6 billion in unrestricted cash. Contact: Primary Analyst Yee Man Chin Director +852 2263 9696 Fitch (Hong Kong) Limited 19/F Man Yee Building 68 Des Voeux Road Central, Hong Kong Secondary Analyst Cathy Chao Associate Director +852 2263 9967 Committee Chairperson Su Aik Lim Senior Director +852 2263 9914 Date of Relevant Rating Committee: 17 October 2017 Summary of Financial Statement Adjustments - Leasing entity deconsolidated: Fitch has deconsolidated Huitong Xincheng, the 100%-owned subsidiary of China Grand Auto, which is engaged in the leasing business. Media Relations: Wai-Lun Wan, Hong Kong, Tel: +852 2263 9935, Email: wailun.wan@fitchratings.com. 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