(The following was released by the rating agency)
HONG KONG, July 23 (Fitch) Fitch Ratings has affirmed China Oriental Group Company Limited’s (China Oriental) Long-Term Foreign Currency Issuer Default Rating (IDR) at ‘BB+’ with a Stable Outlook. The agency has also affirmed the Chinese steelmaker’s senior unsecured rating at ‘BB+'.
The ratings are affirmed despite a rise in leverage, as measured by net adjusted debt/EBITDAR, to 2.2x in 2011 from 1.9x a year earlier. This rise is driven primarily by an increase in working capital, a situation that can by reversed by the company’s reduction of its notes receivables balance and/or by increasing its payable days. If China Oriental’s working capital is adjusted to industry norms, leverage would have been around 1.6x in 2011. Fitch estimates that the normalised leverage will be below 2.0x in 2012.
Fitch notes that China Oriental gets higher prices on its sales by granting longer credit terms to its customers, and saves finance costs for its notes payables by shortening its payable days. Thus, the company has extended its working capital to better utilise the cash raised from the USD850m notes issued in 2010. The funds were originally earmarked for expansion, but the company has scaled back capex due to weakening demand.
China Oriental’s ratings are supported by its operational stability. It is one of the few Chinese steel companies that saw higher per ton gross profit for steel products sold in 2011 versus 2010, partly by managing down its energy costs by harnessing power generated from its blast furnaces and sinter plants. China Oriental has also maximised its plant utilisation to enhance cost efficiency, through the use of different iron ore grades. The company’s ratings are also supported by the operational support from one of the world’s largest steelmakers, 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.
China Oriental’s ratings are constrained by its lack of product diversification. Its pace of new product development has been slow given the volatile market conditions across most steel product classes since 2009. H-section and strip products - which are largely commoditised - still form over 72% of the group’s revenue. Given that the company only has committed capex of CNY500m in 2012, Fitch does not anticipate new product offerings to be introduced before 2014.
The Stable Outlook is supported by Fitch’s expectation of a better second-half in 2012. The agency has observed a few trends in the main steel consuming industries that support an improvement in H212 demand for steel in China. Firstly, the year-on-year decline in Chinese residential housing sales has been slowing in recent months. Secondly, automobile production growth has returned to double digits from April 2012. Finally, China’s steel inventory level has fallen to this year’s low in July despite record production of steel products of 84.4 million tons in June 2012.
What could trigger a rating action?
Negative: Future developments that may, individually or collectively, lead to negative rating action include:
- normalised working capital adjusted net debt/EBITDAR above 1.5x for two consecutive years or above 2.0x in any single year;
- any further working capital increases without a corresponding increase in revenue
- significant weakening of China Oriental’s strategic and operational ties with ArcelorMittal
Positive: No positive rating action is anticipated over the next 24 months given China Oriental’s low degree of product diversification and small operating scale.