Fitch Affirms West China Cement at 'B+'; Outlook Stable
The affirmation reflects Fitch's expectation that WCC will be able to maintain its leading market position in its core market, Shaanxi, and that cement prices and volumes in WCC's key markets are unlikely to deteriorate. However, WCC has substantial short-term debt maturing in 12 months, and failure to extend the maturities may lead to negative rating action.
KEY RATING DRIVERS
Continued Weak Performance: WCC's 1H16 results worsened, but continued to be within the profitability guidelines for its current rating. EBITDA declined 5% year-on-year and gross profit/tonne (before depreciation) decreased to CNY65 from CNY70 a year earlier and CNY67 in 2H15. This was the result of a 7% fall in cement average selling price (ASP). Sales volumes, however, increased 8% in 1H16, mostly driven by additional capacity.
We expect WCC's cement and clinker sales volume to increase by 2% annually in 2016-2018 driven by a slow recovery in cement demand. However, a mild recovery in demand is likely to be absorbed by the excess supply, leading to a 3% decline in ASP in 2016 and no improvement after that, in our view. We expect WCC's gross profit/tonne (before depreciation) to remain around CNY65 in 2016-2018.
Leverage to Remain High: WCC's cash cycle has extended to 65 days in 1H16 from 55 days in 2015, by our estimate, caused by longer receivable days and shorter payable days. The company expects the payable days to normalise in the rest of this year. We expect WCC's FFO net leverage will remain around 4x (2015: 4x) as the tough operating environment will continue to suppress FFO even as the company trims its capital expenditure to generate positive free cash flow.
Liquidity Pressure: WCC's short-term debt increased to CNY1.3bn at end-2015 and remained at the same level at end-1H16, compared with its unrestricted cash of CNY507m at end-1H16. The company did not take steps to improve its debt maturity profile in 1H16 as it expected to refinance its debt after Anhui Conch Cement Company Limited (Conch; A-/Stable) took a controlling stake in WCC. However, the planned acquisition was terminated on 30 June 2016. We now expect WCC to focus on improving its debt maturity profile over the next 12 months. Failure to do so may result in negative rating action as its liquidity profile does not support the current rating.
Conch Shareholding May Be Beneficial: Conch has retained its 21.17% stake in WCC, despite terminating plans to acquire a controlling stake. This makes it the second-largest shareholder of WCC with two non-executive directors on WCC's eight-member board. We believe a collaboration between Conch and WCC can speed up the transition to disciplined supply in the Shaanxi cement market given Conch has been a price setter in the Shaanxi market.
Fitch's key assumptions within our rating case for the issuer include:
- WCC's market share remains stable in Shaanxi
- Average selling price to fall 3% in 2016 and remain unchanged in 2017
Positive: Future developments that may, individually or collectively, lead to positive rating action include:
- FFO-adjusted net leverage sustained below 3.5x
- Gross profit per tonne sustained above CNY70
- Sustained positive FCF
Negative: Future developments that may, individually or collectively, lead to negative rating action include:
- FFO-adjusted net leverage sustained above 4.5x
- Gross profit per tonne sustained below CNY50
- Failure to work towards improving debt maturity profile by 2017
FULL LIST OF RATING ACTIONS
West China Cement Limited
Long-Term IDR affirmed at 'B+' '; Outlook Stable
Senior unsecured rating affirmed 'B+'; Recovery Rating of 'RR4'
Rating on USD400m senior unsecured notes due 2019 affirmed at 'B+'; Recovery Rating of 'RR4'