S&P: Weichai Power Co. Ltd. 'BBB' Rating Affirmed With Negative Outlook; Off Watch Negative
We affirmed the rating because we expect Weichai's leverage to gradually improve 12 months after it completes the acquisition of DH Services Luxembourg Holding s. a.r. l (Dematic). The company's leverage will deteriorate over the 12 months following this acquisition.
We estimate that Weichai's adjusted debt-to-EBITDA ratio will increase to 1.8x-2.2x in the coming 24 months following its acquisition of Dematic, from 1.3x at the end of 2015. We anticipate that the ratio will gradually decrease to 1.5x-1.7x after 24 months due to solid operating cash flows and improving profitability at Dematic. However, this improvement is subject to some market and execution risks. Weichai plans to roll out several initiatives to improve the operating performance and profitability of Dematic. We anticipate that the acquisition of Dematic will close at the end of 2016.
"Weichai's profitability should improve moderately in the coming 24 months, with lower volatility," said S&P Global Ratings credit analyst Stanley Chan. "We expect the company's EBITDA margin to expand to about 13% during this time largely due to the consolidation of Dematic, which has higher margins. Meanwhile, we expect Weichai's existing operations to remain stable over the next 12 months."
We believe Weichai's market share gains from product upgrade to 12 and 13 liter engines and ongoing efforts to cut overhead costs will underpin its margins. Overall, we believe the company's profitability will become less volatile with the increased business diversity.
With the ongoing consolidation of KION Group AG, acquired a few years ago, and pro forma for the proposed Dematic acquisition, Weichai has materially reduced its business exposure to China's volatile and cyclical heavy vehicle market, in our view.
We believe that Weichai will selectively engage in small-scale acquisitions of Chinese renminbi (RMB) 500 million-RMB600 million in the coming 24 months. The company has made several large strategic acquisitions in the past, including forklift and warehouse trucks manufacturer, Germany-based KION, and logistics automation systems and solutions provider, Luxembourg-based Dematic. Weichai will likely primarily focus on operational integration among the newly acquired businesses and roll out new business initiatives.
Weichai's competitive position is at the lower end of the satisfactory category, and the company is yet to establish a more prudent record of stable performance along with consolidation of overseas operations. Our comparative rating analysis of Weichai is therefore negative. However, we expect the company to gradually benefit from the KION acquisition and lower concentration in China's heavy duty truck market, and improve its performance stability.
"The negative outlook reflects our view that the group will face deleveraging challenges if management fails to effectively integrate the new acquisition over the next 12 months," said Mr. Chan.
We believe Weichai's debt-to-EBITDA ratio will increase to 1.8x-2.2x over the next 12-24 months following the Dematic acquisition, and then gradually decrease.
We may lower the rating if Weichai does not deleverage such that its debt-to-EBITDA ratio remains materially above 2.0x in the coming 12-24 months after the completion of the Dematic acquisition. This may happen if: (1) Weichai's business performance and profitability deteriorate, largely because of unfavorable market conditions; (2) the company follows a strategy of making more debt-funded acquisitions and capital expenditure; or (3) its working capital management weakens due to execution and market risks.
We may also lower the rating if Weichai's competitive position weakens, resulting in a substantial decline in market share or failure to achieve stability in profitability.
We may revise the outlook to stable if Weichai's debt-to-EBITDA ratio consistently decreases after the completion of the Dematic acquisition and remains below 2.0x for a prolonged period. This may happen if Weichai is able to realize significant cost and operational synergies from its acquisition of KION and Dematic, while keeping its operating cash flows strong.