September 13, 2017 / 8:10 AM / a year ago

Fitch Rates Weichai's USD Perpetual Securities at 'BBB'

(The following statement was released by the rating agency) HONG KONG/SHANGHAI, September 13 (Fitch) Fitch Ratings has assigned Weichai Power Co., Ltd.'s (Weichai, BBB+/Stable) USD775 million senior perpetual capital securities a final rating of 'BBB'. The perpetual capital securities are issued by Weichai International Hong Kong Energy Group Co., Limited, and unconditionally and irrevocably guaranteed by Weichai. Fitch accords no equity credit to the issuance in the agency's evaluation of Weichai's capital structure and leverage, as this instrument ranks pari passu with Weichai's other unsecured, unconditional and unsubordinated obligations. The final rating and equity credit are the same as the expected rating assigned on 1 September 2017. The perpetual securities are rated one notch below Weichai's 'BBB+' Issuer Default Rating, in accordance with Fitch's "Non-Financial Corporates Hybrids Treatment and Notching Criteria". This one-notch difference reflects the notes' coupon-deferral feature. KEY RATING DRIVERS Financial Profile Withstands Shocks: The financial profile is comparable with 'A-' rated diversified manufacturing and capital goods peers. We expect Weichai's FFO and FCF margins to be sustained above 8% and 4%, respectively, in the medium term; the FFO margin has been at least 10% during 2013-2016. Even with the acquisition of Dematic (an automation and supply-chain management specialist), we expect FFO adjusted net leverage to decline in 2017 and FFO fixed-charge coverage to stay above 6x in normal years. Core Consistently Net Cash: Weichai has consistently maintained a net cash position through multiple industry cycles after deconsolidating German forklift manufacturer KION; we deconsolidate KION in our analysis as Weichai has no direct access to KION's cash. We consider this strong evidence of Weichai's business stability and conservative management team. Weichai, as a state-owned enterprise in China, enjoys strong access to external financing channels including onshore and offshore banks and capital markets. Leader in Key Markets: Weichai is a leader in some key markets, retaining its position as the largest manufacturer of heavy duty truck (HDT) engines and the fourth-largest heavy duty manufacturer in China. Through its control of KION, Weichai is the largest company in the European forklift market and the second-largest in global forklifts. The acquisition of Dematic makes Weichai the largest supply-chain solutions company in North America and a top three firm globally. Weichai is actively developing its technology and know-how, with a strong distribution network, and service network to create moderate-to-high entry barriers. Weichai historically spends 3%-5% of its revenue on R&D each year. Dematic Acquisition Offers Diversification: In November 2016, KION completed the acquisition of Dematic, the world's third-largest automatic logistics solutions provider; Dematic is more focused on the Americas, and boosts Weichai's exposure to aftermarket services revenues. We expect the company to continue to diversify its business portfolio through new product and market development as well. Strong HDT Demand in 1H17: Results exceeded our expectations as the HDT market continued to improve. The sector benefitted from several factors, including replacement demand as trucking fleets aged; emission upgrades; sustained fixed-asset investment (FAI) growth; and the continued investment in China's logistical infrastructure. The general market strength and market share gains contributed to engine sales rising by 90% yoy to CNY20.5 billion and operating margins expanding by 3.1pp to 14.1%. However, we expect a modest pull-back in HDT demand in 2018 and 2019. DERIVATION SUMMARY Fitch's 'BBB+' rating reflects Weichai's financial structure, flexibility, and profitability (FFO margin of more than 8% in the medium term) relative to rated diversified manufacturing and capital goods peers. The financial profile is comparable with 'A-' rated peers, and is relatively stronger than 'BBB+' rated companies such as Eaton Corporation plc and IDEX Corporation. The rating is supported by a leadership position in several key markets, and management's conservative financial policies and demonstrated execution. The ratings are constrained by its relative scale and positioning against global peers, including Caterpillar Inc. (A/Negative), AB Volvo (BBB/Stable) and Cummins, which are capable of competing globally and with more diverse business portfolios. KEY ASSUMPTIONS Fitch's key assumptions within the rating case for Weichai include: - HDT truck sales and HDT engine sales to decline by about 10% from 2017 levels - Forklift sales will grow at a mid-single-digit rate with stable margins - Total revenue to grow by 43%, -4%, and -2% for 2017, 2018, and 2019 - Total capex to be less than CNY15 billion in the next three years - Dividend pay-out ratio to be around 50% RATING SENSITIVITIES Positive: Developments that may, individually or collectively, lead to positive rating action include: - A significant change in Weichai's business profile leading to an improvement in scale and diversification in terms of business profile and geography. Negative: Developments that may, individually or collectively, lead to negative rating action include: - Engine and forklift businesses lose competitive edge on a sustained basis - FCF turns negative on a sustained basis (deconsolidated) - Failure to maintain a net cash position on a sustained basis (deconsolidated) - Failure to maintain control over KION group - FFO adjusted net leverage sustained above 1x (consolidated) LIQUIDITY Weichai's liquidity is supported by available cash of CNY21.6 billion as of end-2016 and large unused banking facilities of CNY41.7 billion, compared with CNY9.7 billion of debt due at end-2017. Contact: Primary Analyst Laura Zhai Director +852 2263 9974 Fitch (Hong Kong) Limited 19/F Man Yee Building 68 Des Voeux Road Central, Hong Kong Secondary Analyst Charles Li Analyst +86 21 5097 3016 Committee Chairperson Sui Aik Lim Senior Director +852 2263 9914 Date of Relevant Rating Committee: 1 September 2017 For regulatory purposes in various jurisdictions, the supervisory analyst named above is deemed to be the primary analyst for this issuer; the principal analyst is deemed to be the secondary. Media Relations: Wai-Lun Wan, Hong Kong, Tel: +852 2263 9935, Email: Additional information is available on Applicable Criteria Corporate Rating Criteria (pub. 07 Aug 2017) here Non-Financial Corporates Hybrids Treatment and Notching Criteria (pub. 27 Apr 2017) here Additional Disclosures Dodd-Frank Rating Information Disclosure Form here Solicitation Status here Endorsement Policy here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. 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