(The following statement was released by the rating agency)
Sept 26 -
Summary analysis -- China Lumena New Materials Corp. -------------- 26-Sep-2012
CREDIT RATING: B+/Stable/-- Country: China
Mult. CUSIP6: 550243
Credit Rating History:
Local currency Foreign currency
20-Sep-2011 B+/-- B+/--
07-Oct-2009 BB-/-- BB-/--
The rating on China Lumena New Materials Corp. (Lumena) reflects the company’s high revenue concentration in a niche market, limited distribution channels, high counterparty risk exposure, and aggressive expansion. Lumena’s leading domestic market positions and high but declining profitability temper the above strengths. Lumena is a China-based thenardite and polypehnylene sulfide (PPS) producer.
We believe Lumena’s dependence on market growth to meet its growing production capacity and to absorb its new products undermines its “weak” business risk profile, as our criteria define the term. The company also has limited channels of product distribution. We believe that the inclusion of PPS as a key product in the government’s 12th five-year plan for the new material industry will help the PPS business. The emission standards that the government announced last year, particularly those for the power sector, should also support Lumena’s PPS fiber business in particular.
Lumena’s profit margins have declined in line with our expectations due to a change in the product mix, a fall in specialty thenardite prices due to increased competition, and higher raw material costs. During the first six months of 2012, gross margins (including depreciation) in the thenardite business fell 4.7%, while those in the PPS segment declined 2.1% compared to full-year 2011. We expect the margin compression to continue due to rising raw material costs and the lag in passing on the cost increases to customers.
Revenue concentration remains high for Lumena. PPS compounds and medical thenardite contributed nearly 44.6% and 19.7% of Lumena’s revenues, respectively, in the first half of 2012. The company is also highly exposed to the counterparty credit risks of its distributors, particularly in its PPS business. In the first half of 2012, the top five PPS distributors accounted for 76% of the segment revenue (and 49% of the total revenue). Synergies between Lumena’s thenardite and PPS businesses remain limited, with internal sales of thenardite (used as raw material for PPS) accounting for only 5.9% of its gross thenardite revenues in the first half of 2012.
The absence of Lumena’s majority owner Mr. Suo Lang Duo Ji on the company’s board is a risk, in our view. We note that Mr. Suo Lang could use his ownership in Lumena to fund his other business interests. Should this occur, the company could face liquidity pressure given a change-of-control clause for its outstanding bonds and bank loans.
Lumena continues to aggressively expand its PPS capacity. This exposes the company to execution risks and makes it heavily dependent on the prospects of increasing PPS demand or improving market share to meet the additional supply. Lumena’s expansion of its PPS resin capacity to 55,000 tons from 30,000 tons and of its PPS fiber capacity to 20,000 tons from 5,000 tons is on track and is likely to be completed by the end of 2012. The company has also commenced Phase II of this expansion this year. This phase will increase PPS resin capacity to 80,000 tons by 2014.
Lumena’s “aggressive” financial risk profile, as our criteria define the term, is better than similarly rated peers’. Lumena’s EBITDA interest coverage was 4.5x for the first half of 2012 and we expect this ratio to be above 5x for the full year. Nonetheless, the company’s expansion strategy will require external sources of capital. We see this as a challenge given Lumena’s limited funding channels.
We believe Lumena has “adequate” liquidity, as our criteria define the term. Our assessment of the company’s liquidity profile incorporates the following expectations and assumptions:
-- Lumena’s liquidity sources, including cash and equivalents, will exceed liquidity uses by 1.2x or more in the next 12-18 months.
-- Net sources will remain positive even if EBITDA declines by 15%-20%.
-- The company’s liquidity sources include Chinese renminbi (RMB) 2.8 billion of cash on hand of as of June 30, 2012, and our expectation of about RMB1.9 billion in funds from operations in 2012.
-- We project Lumena’s uses of liquidity in 2012 at about RMB4 billion. They include capital expenditure, debt repayment, dividend payment, and projected working capital requirements.
The stable outlook reflects our expectation that Lumena’s liquidity position will remain adequate in the next 12-18 months. It also reflects our view that the company’s interest coverage ratios will still support the rating, given Lumena’s still good EBITDA generation, even if operating margins continue to weaken, as we expect they will.
We may lower the rating if: (1) Lumena’s expansion plans lead to a material deterioration in its liquidity position and higher-than-expected execution risk; or (2) the company’s major shareholder undertakes any transaction to extract value from it.
The rating upside potential in the next 12 months is limited. Nevertheless, we may consider raising the rating if: (1) Lumena completes the new PPS capacity expansion on time and within budget; (2) demand for the company’s niche products remains strong; and (3) Lumena materially diversifies its revenue and reduces its counterparty credit risk exposure.
Related Criteria And Research
-- Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012
-- Criteria For Rating Companies In The Global Commodity Chemicals Industry, Sept. 12, 2012
-- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011
-- Key Rating Factors: Methodology And Assumptions On Risks In The Mining Industry, June 23, 2009