The rating actions reflect our view that Lonking has reduced refinancing risks relating to its convertible bonds issued in 2009. The bonds had US$168 million outstanding and were due Aug. 24, 2012. By the due date, Lonking had purchased US$5.2 million convertible bonds from the market using its own cash. It also redeemed bonds under the early redemption notices from holders, with an aggregate redemption price of US$156.7 million (Chinese renminbi 987 million), through offshore borrowings.
We assess Lonking’s business risk profile as “weak,” as defined in our criteria. The company’s profit margins have declined significantly due to rising operating and financing costs, and increasing competition from domestic and international players. Lonking has also lost its competitive position in its key product segments in China as its competitors adopted more aggressive pricing and financing strategies.
We expect Lonking’s financial performance to be adequate for the rating despite a weaker showing in the first half of 2012 than we expected. In our revised base-case scenario, we estimate Lonking’s sales to be RMB10 billion in 2012, with gross margin of 24%. Its ratio of funds from operations (FFO) to debt is likely to fall to about 13% from 27.2% in 2011. The debt-to-capital ratio will likely stay at about 50%.
Lonking’s smaller revenue base than global peers’, its limited geographic and product diversity, and regulatory risks from possible changes in government policies also constrain the ratings. Lonking’s established market position in wheel loaders, its extensive sales and distribution network across China, and its operational record partly offset these risks.
We lowered the issue rating on Lonking’s US$350 million senior unsecured notes to one notch below the corporate credit rating because we believe the company’s ratio of priority debt to total assets will likely be above our threshold of 15% for speculative-grade issuers. The management’s cash tender offer to partially redeem its outstanding offshore senior unsecured notes will likely increase priority debt (including secured debt and onshore debt) to fund working capital in weakening operating conditions.
We assess Lonking’s liquidity to be “less than adequate,” as defined in our criteria. We expect the company’s sources of liquidity to be less than 1.2x its uses in the next 12 months. Our liquidity assessment is based on the following factors and assumptions:
-- Lonking’s liquidity sources total RMB3.0 billion. They include unrestricted cash, FFO, and pledged deposits for bank loans.
-- The company’s uses of liquidity total RMB2.9billion, and include capital expenditure, working capital needs, debt repayment, and dividend distribution.
-- We expect Lonking’s net liquidity sources to turn negative if EBITDA declines by 10% from our base case.
The negative outlook reflects the uncertainty of recovery in the company’s sales and profitability over the next six to 12 months.
We could lower the rating if Lonking’s financial performance weakens, such that its ratio of FFO to total debt is less than 12% or its ratio of total debt to total capital exceeds 60%. This could happen if the company’s operating conditions deteriorate more than we expect or its market position weakens further due to increasing competition or adverse government policies.
We may revise the outlook to stable if the operating conditions stabilize, leading to greater visibility on price and demand. A ratio of FFO to debt above 15% and an improvement in Lonking’s liquidity to “adequate” could trigger an outlook revision.
Related Criteria And Research
-- Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011
-- Criteria Methodology: Business Risk/Financial Risk Matrix Expanded, May 27, 2009
-- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008
-- 2008 Corporate Criteria: Ratios And Adjustments, April 15, 2008
Ratings Affirmed; CreditWatch/Outlook Action
Lonking Holdings Ltd.
Corporate Credit Rating BB-/Negative/-- BB-/Watch Neg/--
Downgraded; CreditWatch/Outlook Action
Lonking Holdings Ltd.
Corporate Credit Rating
Greater China Regional Scale cnBB/-- cnBB+/Watch Neg/--
Lonking Holdings Ltd.
Senior Unsecured B+ BB-/Watch Neg
Greater China Regional Scale cnBB- cnBB+/Watch Neg