August 23, 2017 / 7:07 AM / a year ago

Fitch Affirms China Lesso at 'BB+'; Outlook Stable

(The following statement was released by the rating agency) HONG KONG/SHANGHAI, August 23 (Fitch) Fitch Ratings has affirmed plastic pipes and fittings manufacturer China Lesso Group Holdings Limited's (Lesso) Long-Term Issuer Default Rating (IDR) and senior unsecured rating at 'BB+'. The Outlook is Stable. The Stable Outlook reflects Fitch's expectation that the profitability of Lesso's core plastic pipes business will remain stable and the company will be able to maintain a low FFO-adjusted net leverage of around 0.6x-1.0x between 2017 and 2020. KEY RATING DRIVERS Stable Profitability: Fitch expects full-year 2017 gross margin to be around 27%, which is similar to that in 2016. Lesso's total revenue increased by 22.6% yoy to CNY9.0 billion in 1H17, driven by a 13.2% yoy growth in sales volume and 7.5% yoy growth in average selling prices (ASP). Gross profit margin contracted to 27.4% in 1H17 from 29.8% in 1H16, mostly due to higher raw material prices. Capex Drives Leverage: Lesso's 2016 capex and equity investments surged to around CNY3.6 billion in 2016, well beyond our expectation of CNY1.5 billion and compared with CNY1.2 billion in 2015. The capex was mainly used to expand Lesso's production bases and its Lesso Mall e-commerce platform. Lesso recorded around CNY1.5 billion in capex and CNY700 million in equity investments in 1H17, and Fitch expects capex for the full year to remain high at around CNY2.8 billion, before decreasing to CNY1.5 billion in 2018. The sharp rise in capex sent Lesso's net debt higher to around CNY2.9 billion by end-1H17 from CNY1.6 billion at end-2016. However, Fitch expects Lesso's FFO adjusted net leverage to remain low at 1.1x in 2017 and 0.9x in 2018 as we expect the company's ability to generate cash flows to remain strong. Market Position Remains Dominant: Lesso has maintained its leading position in China's plastic pipes market with 15%-18% share by volume and around 45%-50% share in its home market of southern China at end-2016. Fitch expects Lesso to continue to dominate the market in southern China while increasing its presence in other regions, the company recently completed a production facility in Hunan and is expected to commence production in 2H17. Infrastructure to Support Demand: Government infrastructure construction accounts for about 70% of Lesso's total revenue and Fitch expects Lesso's sales volume to be supported by increased fixed-asset investment in urban underground pipelines, construction of "sponge cities" that channel rainwater to prevent floods and for use, and water treatment facilities. These will be partly offset by slower FAI growth in the property sector. Geographic Concentration a Constraint: Around 60% of Lesso's revenue in 2016 came from southern China, one of the most developed markets in the country. However, this geographic concentration presents a business risk and is a constraint on Lesso's IDR. DERIVATION SUMMARY Compared with Tata Chemicals Limited (TCL, BB+/Stable), which is similar in EBITDA size, Lesso has higher and more stable margins, more consistent FCF generation, higher coverage ratios and lower FFO net leverage. However TCL has greater geographic diversification than Lesso, with around 60% of its revenue derived from the growing markets of India and about 35% from developed markets in the US and Europe. As a result, they are rated at the same level. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: - Plastics pipes sales volume to increase by 11% in 2017 and 8% in 2018 - Gross margin to remain at around 26% between 2017 and 2019 - Capex of CNY2.8 billion in 2017 and CNY1.5 billion each year in 2018 and 2019 RATING SENSITIVITIES Developments That May, Individually or Collectively, Lead to Positive Rating Action - Significant increase in market share in the domestic plastic pipes and fittings sector and establishment of a strong presence outside southern China Developments That May, Individually or Collectively, Lead to Negative Rating Action - EBITDA margin sustained below 15% (2016: 17.9%) - FFO adjusted net leverage sustained above 1.0x - Sustained negative free cash flow LIQUIDITY Adequate Liquidity: Lesso has around CNY4.2 billion of short-term debt as of end-2016, which was well covered by CNY3.1 billion of cash on hand and over CNY10 billion of unused credit facilities. Contact: Primary Analyst Laura Zhai Director +852 2263 9974 Fitch (Hong Kong) Limited 19/F Man Yee Building 68 Des Voeux Road Central, Hong Kong Secondary Analyst Charles Li Analyst +86 21 5097 3016 Committee Chairperson Kalai Pillay Senior Director +65 6796 7221 . Media Relations: Wai-Lun Wan, Hong Kong, Tel: +852 2263 9935, Email: Additional information is available on Applicable Criteria Corporate Rating Criteria (pub. 07 Aug 2017) here Additional Disclosures Dodd-Frank Rating Information Disclosure Form here Solicitation Status here Endorsement Policy here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEB SITE AT WWW.FITCHRATINGS.COM. PUBLISHED RATINGS, CRITERIA, AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. 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