OREANDA-NEWS. Fitch Ratings has downgraded Yingde Gases Group Company Limited's (Yingde) Long-Term Issuer Default Rating (IDR) to 'B+' from 'BB'. The Outlook is Stable. The agency has also downgraded the senior unsecured debt ratings of Yingde and Yingde Gases Investment Limited to 'B+' from 'BB'; with Recovery Rating of 'RR4'. A full list of rating actions is at the end of this commentary.

The downgrade reflects the increase in Yingde's customer risk and weakening bargaining power, especially in the steel sector, where financial positions have deteriorated due to persistent industry weakness.

The higher risks are evident in Yingde's recent announcement that it has lost control of its Pingshan Plant after the customer occupied it; its inability to collect payments fully from Shaanxi Longmen Iron and Steel Co., Ltd. since 2013; and steelmakers accounting for around 70% of Yingde's customers. Yingde's receivable days have lengthened and the proportion of delinquent receivables has remained large, which have led to deterioration in its leverage position.

The Stable Outlook reflects our expectation that its FFO-adjusted net leverage would remain at around 5.0x, which is commensurate with its current ratings. The Stable Outlook assumes there is no substantial increase in both its account receivable days and trade receivable delinquency rate; and Yingde will not lose control over its other assets.

KEY RATING DRIVERS

Sustained High Receivables Risk: Yingde's accounts receivable days rose to 103 days in 2015 from around 99 days in 9M15. However, its accounts payable days decreased to 37 days from around 52 days. This drove an increase in cash collection days to 73 days in 2015 (9M15: 52 days), which is above the level that would trigger Fitch to consider negative rating action. The deterioration in collection is partly mitigated by its bills receivable, which account for 31% of net accounts receivables and can be readily converted into cash at a discount.

Meanwhile, the company's delinquent receivables increased by 10% yoy in 2015 to account for 59% of total net trade receivables. Yingde's bad debt provision jumped by 62% yoy to CNY377m. The company has not yet collected the overdue receivable in full from Shaanxi Longmen Steel even after filing lawsuits. In addition, Yingde said on 22 March that one of its plants that operates three on-site facilities was occupied by its client Hebei Jingye Steel and Iron Company Limited. This happened after Yingde planned to stop supplying gas to the client, which had not paid Yingde a substantial amount for its gas.

Challenges for On-Site Business: Yingde's business model of focusing on on-site plants is exposed to rising uncertainties and challenges during the current sluggish operating environment. Normally, the on-site business has much lower exposure to economic cycles compared with the merchant segment because the former contains take-or-pay terms and exclusive contracts with very long periods. However, most of Yingde's on-site plants are running around the minimum take-or-pay level due to low utilisation by its clients. In 2015, revenue from the on-site business edged up 2.7% yoy to CNY6,886m compared to 10.9% yoy increase in 2014.

Heavy Reliance on Steel: It is unlikely Yingde's operations will recover in the short term because around 70% of its customers are in the steel sector, which continues to be plagued with overcapacity, low utilisation rates and soft average selling prices. Fitch expects the industry to undergo major restructuring in the medium term, particularly the small and medium-sized companies, as China moves to reduce steel capacity and address the tight liquidity and high leverage of the industry.

Near-Term Deleveraging Not Likely: Fitch expects Yingde's 2015 FFO-adjusted net leverage to rise above 4.6x from 4.4x in 2014, breaching our negative trigger of 4.0x. In the near term, we expect its leverage to remain high at around 5x, mainly due to weakness in the steel and chemical sectors. Slower revenue growth and rising cash interest costs have resulted in smaller FFO, even though its operating EBITDA margin has been stable. The company has had to increase debt to fund its capex and common dividend payment.

Negative Free Cash Flow: We expect Yingde's free cash flow to remain negative due to the sluggish steel sector, even though it has reduced capex. The company's capex spending will be for diversifying its customer base to non-steel sectors, such as non-ferrous metal, glass, coal chemical and petrochemical. However, these sectors are also subject to overcapacity and weak demand in China. Yingde has been generating negative free cash flow over past few years due to its aggressive investments to add capacity, and the current weak operating environment means payback will take much longer than expected. Free cash flow is unlikely to turn positive until the company collects on its substantial accounts receivable.

KEY ASSUMPTIONS

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

- No significant changes in its business model and no material increase in its business risk;
- No deterioration in account receivable collection risk;
- Occupation of the Pingshan Plant or similar incidents do not occur at Yingde's other assets;
- Capex of CNY1.5bn in 2016 and CNY1.25bn in 2017;
- Dividend payout to remain the same as in 2015;
- 31%-33% gross margin between 2016 and 2018.

RATING SENSITIVITIES

Negative: Developments that may, individually or collectively, lead to negative rating action include:
- Material deterioration of its onsite gas supply business model, which may be evident in a significant decline of its top line or operating EBITDA margin;
- Sustained high delinquency rate on trade receivables, after adjusting for the impact of any large write-offs;
- Account receivable days sustained above 105 days;
- FFO-adjusted net leverage sustained above 5.5x.

Positive: Developments that may, individually or collectively, lead to positive rating action include:
- Significant, sustainable improvement in the delinquency rate on trade receivables, after adjusting for the impact of any large write-offs;
- Account receivable days sustained below 70 days;
- FFO-adjusted net leverage sustained below 4.0x.

FULL LIST OF RATING ACTIONS

Yingde Gases Group Company Limited
Long-Term Issuer Default Rating downgraded to 'B+' from 'BB'; Outlook Stable
Senior unsecured debt rating downgraded to 'B+' from 'BB'; Recovery Rating of 'RR4'

Yingde Gases Investment Limited
Senior unsecured debt rating downgraded to 'B+' from 'BB'; Recovery Rating of 'RR4'
Rating on USD425m 8.125% senior unsecured notes due 2018 downgraded to 'B+' from 'BB'; Recovery Rating of 'RR4'
Rating on USD250m 7.25% senior unsecured notes due 2020 downgraded to 'B+' from 'BB'; Recovery Rating of 'RR4'
The notes were issued by Yingde Gases Investment Limited and guaranteed by Yingde Gases Group Company Limited