(The following statement was released by the rating agency)
Sept 26 -
-- Texhong's financial strength is improving, as reflected in operating results that exceeded our expectation for the first half of 2012.
-- We believe the business risk profile of the China-based textile company remains "weak," primarily due to its susceptibility to cotton price volatility.
-- We are revising the rating outlook to stable from negative to reflect our expectation that Texhong's credit protection measures will continue to improve over the next 12 months, at least.
-- We are affirming the 'BB-' long-term corporate credit rating and issue rating and raising our Greater China regional scale ratings on Texhong and its outstanding senior unsecured notes to 'cnBB+' from 'cnBB'.
On Sept. 26, 2012, Standard & Poor's Ratings Services revised the rating outlook on Texhong Textile Group Ltd., a China-based textile company, to stable from negative. At the same time, we affirmed our 'BB-' long-term corporate credit rating on the company and our 'BB-' issue rating on the company's US$200 million senior unsecured notes due 2016. We also raised our long-term Greater China regional scale rating on Texhong and its outstanding senior unsecured notes to 'cnBB+' from 'cnBB' to move them in line with the stable rating outlook on Texhong.
We revised the outlook to reflect our expectation that Texhong's "aggressive" financial risk profile, as defined under our criteria, will continue to improve. The company's ratio of total debt to EBITDA declined to about 2.7x in the first half of 2012 from 5.1x in 2011, moving the company further away from our downgrade threshold of 3.5x. In our view, despite the uncertainty in the global economy, the company's profitability and cash flow protection measures will strengthen over the next year because of stabilizing cotton prices and the current wide price differential between cotton selling prices in the U.S. and China.
Texhong's financial risk profile reflects our view of the company's debt-funded expansion to date, its short track record of improving its financial metrics, and tight headroom for one of its financial covenants as of June 30, 2012. Nevertheless, the company's results in the first half of 2012 were substantially better than we expected when we lowered the corporate credit rating to 'BB-' in March 2012 (see " Ratings On Texhong Textile Lowered To 'BB-' On Deteriorating Financial And Business Risk Profiles; Outlook Negative," published on March 22, 2012, on RatingsDirect on the GlobalCreditPortal).
We have revised our base-case projections for 2012. We now expect the company's ratio of total debt to EBITDA to be about 2.5x, compared with 3.0x previously. Texhong's financial health has strengthened primarily because of stabilizing cotton prices since the second half of 2011 and the wide differential between onshore and offshore cotton prices. Further, the company has been able to restore profitability due to better inventory control and expanded capacity in Vietnam after it completed expansion in the south of the country.
The uncertain global economic outlook and volatility in cotton prices demonstrated how vulnerable Texhong's business can be during industry downturns, which underpins our assessment that it has a "weak" business risk profile. In our opinion, Texhong still faces execution risk from its ongoing expansion in northern Vietnam. The company is increasingly subject to country risk in Vietnam, given that about 40% of its capacity is based there as of June 30, 2012; this proportion should later increase to about 50%. However, the company's good niche market position in core-spun yarns and the cost advantage of its Vietnam operations temper these weaknesses.
The affirmed rating also reflects our view of Texhong's narrow product range, lower profitability than that of peers in the 'BB-' rating category, and the competitive and fragmented nature of the textile industry. The company's good niche market position in core-spun yarns, stable cash flows, and a proactive and flexible management team temper these weaknesses. Texhong's steady growth profile, driven by its expansion in Vietnam and above-average operating efficiency, is an additional supporting factor.
We view Texhong's liquidity as "adequate," as our criteria define the term. We believe the company's EBITDA will improve in the second half of 2012 on stabilizing cotton prices. We also expect the company to maintain adequate sources of liquidity to cover its needs, and sufficient buffer above covenant levels. Our assessment of the company's liquidity profile incorporates the following expectations and assumptions:
-- Sources of liquidity, including cash on hand of Chinese renminbi (RMB) 533.3 million as of June 30, 2012, and funds from operations (FFO) of about RMB460 million for 2012, will exceed the company's uses by 1.2x or more over the next 12 months.
-- Liquidity uses include capital expenditure, working capital needs, debt repayments, and dividend payouts totalling about RMB740 million. As of June 30, 2012, Texhong has short-term borrowings of about RMB125 million.
-- Texhong has additional funding channels, including inventory and machinery loans. As of June 30, 2012, the company also has more than RMB600 million in undrawn banking facilities to provide an additional liquidity buffer. However, we don't include these in sources of liquidity because of their uncommitted nature.
-- One of Texhong's financial covenant tests showed limited headroom as of June 30, 2012. We expect the test result to improve significantly at the end of 2012 because of an improvement in the gross margin.
The stable outlook reflects our expectation that Texhong can continue to improve profitability and restore its financial strength over the next 12 months.
We could lower the rating if the financial risk profile deteriorates materially because Texhong engages in large debt-funded expansion, cotton prices fluctuate for a prolonged period, or demand is weak. Downgrade triggers are an adjusted ratio of total debt to EBITDA that exceeds 4.5x and a ratio of FFO to debt that drops to below 15% on a sustained basis.
The upside to the rating is currently limited due to Texhong's high susceptibility to volatile cotton prices. We could raise the rating if the company can demonstrate good execution of its expansion plan in northern Vietnam, better stability across down cycles, or more conservative financial policies, so that the ratio of debt to EBITDA consistently stays below 2.0x.
Related Criteria And Research
-- Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012
-- Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011
-- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008
Texhong Textile Group Ltd.
Ratings Affirmed; Outlook Action
Corporate Credit Rating BB-/Stable/-- BB-/Negative/--
Corporate Credit Rating
Greater China Regional Scale cnBB+/--/-- cnBB/--/--
Senior Unsecured cnBB+ cnBB
Senior Unsecured BB-