OREANDA-NEWS. Fitch Ratings has affirmed China-based chemicals manufacturer Wanhua Chemical Group Co., Ltd's (Wanhua Chemical) Long-Term Foreign-Currency Issuer Default Rating (IDR) and Long-Term Local-Currency IDR of 'BBB-'. It has also affirmed the company's senior unsecured rating at 'BBB-' and the rating on the CNY1bn 4.5% senior unsecured notes due 2017 issued by Wanhua Chemical International Holding Co., Ltd at 'BBB-'. The Outlook is Stable.

Wanhua Chemical and its parent Wanhua Industrial Group Co. Ltd (Wanhua Industrial) have deleveraged more slowly than Fitch expected, with Wanhua Chemical's leverage remaining above 3.5x and Wanhua Industrial's above 4.5x, the previous levels at which Fitch would consider negative rating action. However, the affirmation of Wanhua Chemical's ratings reflects the company's leading global position as the largest producer of methylene diphenyl di-isocyanate (MDI), the key feedstock for production of polyurethane, a widely used plastic material as well as its strong bargaining power in the highly consolidated MDI sector. Fitch expects Wanhua Chemical to begin deleveraging from 2016 and generate positive free cash flow after that.

KEY RATING DRIVERS

Capex Drives Leverage: Wanhua Chemical and Wanhua Industrial's financial leverages, measured by FFO-adjusted net leverage, have remained high and likely ended 2015 at 5.2x and 6.3x, respectively. This was mostly driven by significant capex for the building of its petrochemical business in Yantai, which started production in December 2015.

Weaker MDI Price Hinders Deleveraging: The MDI price weakness, particularly in 2014 and 2015 due to lower oil prices, has had a negative impact on the company's revenue. We expect Wanhua Chemical to start deleveraging from 2016 and its FFO-adjusted net leverage to reach 3.6x and 3.2x in 2016 and 2017, respectively, following EBITDA contribution from its new petrochemical business and significant reduction in capex. However, further weakness in oil prices could reduce EBITDA from the MDI business and may result in delays in deleveraging. A 10% drop in MDI average selling prices (ASP) would push FFO-adjusted net leverage to 3.9x in 2016, compared with our base case of 3.6x.

Petrochem Business Untested: Wanhua Chemical's petrochemical business commenced operation in December 2015. While this helps in the diversification of its highly concentrated business profile, and potentially further vertical integration and lower costs, execution risks exist as this would be the company's first attempt at the business. Uncertainties remain in increasing output from the plant and its ability to generate desirable top line and margins.

Still MDI Market Leader: Wanhua Chemical's strong business profile is underpinned by its position as the global market leader in its core product, MDI. The global MDI market is highly concentrated, with Wanhua Chemical and its parent Wanhua Industrial being the largest producers with a total capacity of over 2 million tonnes, or around 30% of global aggregate output at the end of 2014 (up from 22% in 2013).

Wanhua Chemical is the low cost leader in the MDI industry and has demonstrated an ability to pass through cost fluctuations to its customers, which is reflected in its ability to sustain a stable gross profit margin at above 30%, despite the weak petrochemical environment caused by a slump in oil prices.

Positive FCF in 2016: We expect both Wanhua Chemical and Wanhua Industrial to generate positive free cash flow (FCF) from 2016, primarily due to reductions in capex and low dividend payouts. We expect capex for Wanhua Chemical to decrease by over 50% in 2016. Wanhua Chemical has also said it has no plans to expand MDI capacity in the near future.

KEY ASSUMPTIONS

Fitch's key assumptions within our rating case for the issuer include:

- Inclusion of contributions from Wanhua Chemical's petrochemical business and new polycarbonate business in 2016
- No MDI capacity expansion plan going forward
- Considerable capex reduction from 2016 for both Wanhua Chemical and Wanhua Industrial
- Lower dividend payout for Wanhua Chemical

RATING SENSITIVITIES

Negative: Future developments that may, individually or collectively, lead to negative rating action include:
- Loss of leading market positions in core segments
- Failure to execute its expansion plans
- Wanhua Industrial's operating EBITDA margin falling below 15% on a sustained basis (2014: 22%)
- Failure to generate positive free cash flow for both Wanhua Chemical and Wanhua Industrial by 2017
- Wanhua Industrial's FFO-adjusted net leverage sustained above 5.0x
- Wanhua Chemical's FFO-adjusted net leverage sustained above 4.0x

Positive: Fitch does not envisage any positive actions over the next 12 months due to the company's high financial leverage.