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Fitch Assigns Tunghsu First-Time 'B+' Ratings; Outlook Stable
May 31, 2017 / 11:48 AM / 7 months ago

Fitch Assigns Tunghsu First-Time 'B+' Ratings; Outlook Stable

(The following statement was released by the rating agency) HONG KONG, May 31 (Fitch) Fitch Ratings has assigned Tunghsu Group Co., Ltd. a Long-Term Issuer Default Rating (IDR) and senior unsecured rating of 'B+', with Recovery Rating at 'RR4'. The Outlook is Stable. Fitch has also assigned a 'B+(EXP)' expected rating with Recovery Rating of 'RR4' to the proposed US dollar senior notes issued by Tunghsu Venus Holding Limited, an indirect wholly owned subsidiary of Tunghsu. The notes are guaranteed by Tunghsu and are rated at the same level as Tunghsu's senior unsecured rating because they constitute its direct and senior unsecured obligations. The final rating is subject to the receipt of final documentation conforming to information already received. Tunghsu is a China-based holding company primarily engaged in the manufacturing of optoelectronic displays and has recently expanded into the high-end equipment manufacturing, new energy, real estate, green construction material and finance businesses. Tunghsu's ratings are supported by its established, leading position in the optoelectronic display industry, its diversified funding channels and a strong liquidity profile. Tunghsu's ratings are constrained by its product and geographical concentration, a short track record in segments that are outside its main optoelectronic display business, structural subordination, as well as higher leverage to fund its expansion in the next three years. KEY RATING DRIVERS Niche Market Leader: Tunghsu Group's core business is operated through its listed affiliate Dongxu Optoelectronic Technology Co Ltd (DXGD), China's largest glass-substrate producer. Despite the low shareholding of 18.13%, Tunghsu holds key patents for DXGD's production, which is crucial in an industry with high technological and capital barriers. Tunghsu is the only domestic player manufacturing a complete set of equipment for both TFT-LCD glass substrates and touch-screen glass, accounting for about 11% of China's production volume of glass substrate for sizes up to G6 and 1.6% globally in 2016. DXGD's low-cost base compared with foreign players has helped it to maintain gross profit margins above 30%-40%, supported by favourable industry policies to localise and lower labour costs. DXGD's high-end equipment capability has enabled the company to build its production lines in-house, saving the company up to 25% in capital expenditure. We expect margins to remain high for glass substrates in the medium term as the average selling price has stabilised after its key competitor Corning ceased production of its lower-end lines for glass sizes less than G6. Structural Subordination: Tunghsu Group operates two of its four key business segments, namely optoelectronic displays and solar farm operation, through its two listed affiliates, obtained through backdoor listings. Other than DXGD, it owns 30.98% of Tunghsu Azure Renewable Energy Co Ltd (DXLT), under which it operates its solar farm business. Tunghsu's access to its listed affiliates' cash is limited by their dividend policies due to material minority interests. Therefore, we have taken a proportionate consolidated approach to evaluate Tunghsu's financial profile. Historically, Tunghsu has pledged a large portion of the listed affiliates' shares to banks. We expect this practice to remain a regular source of funding for the group, given the lower financing cost and the group's continuous funding needs to support its listed businesses. Limited Record on New Business: Tunghsu's businesses outside of optoelectronic display industry were established in the last two years. We expect its high-end equipment manufacturing segment to be the key driver of its EBITDA generation in the next few years given its relatively larger scale, high-margin nature and low operating leverage. However, Tunghsu's orderbook history in this segment is quite volatile and orderbook backlog in 4Q16 was 20% of 2016 revenue. Tunghsu relies on continuous incoming orders to sustain the segment's revenue. In addition, Tunghsu has accelerated its expansion in solar farm construction since 2016. The strategy entails high execution risk for a new entrant in the capital intensive, regulation-driven, highly competitive solar plant industry. There is low visibility on DXLT's competitive position, and its source of funding to support its aggressive construction plan of 2GW within the next two years, and another 2GW in 2019-2021. Currently the largest PV power plant investor in China has on-grid installed capacity of 1.4GW. Capex in the next three years will be over CNY20 billion. Leverage to Increase: On a proportionate consolidated basis, Tunghsu's FFO-adjusted net leverage was 5.4x and 2.5x in 2015 and 2016, respectively, and Fitch expects this to increase to 3x-3.5x in 2017, including the CNY3.7 billion debt guarantee to DXLT. The higher leverage is mostly driven by the high capex plan of its two listed affiliates, of which Tunghsu will contribute on a proportionate basis. Tunghsu's financial profile has lower predictability due to its opportunistic expansion and the continuous funding needs of its listed affiliates, which plan to fund most of their expansion through equity placements. Tunghsu will continue to participate in the placements to avoid a dilution of its stakes. Both DXGD and DXLT operate in industries that require significant capital investments. Diversified Funding Channels: Tunghsu has established diversified funding channels in recent years. DXGD and DXLT have completed CNY25 billion in private placements within the last two years, and expect to launch another CNY8.6 billion placement subject to exchange approval in 2017. At end-2016, Tunghsu had CNY15.2 billion in onshore bonds outstanding. In addition, Tunghsu has the support of its second-largest shareholder Huarong Trust International (with 25% interest) in terms of short-term facilities and co-investment opportunities. DERIVATION SUMMARY Tunghsu's profile is comparable with its peers with 'B+' ratings. Tunghsu's proportionately consolidated EBITDA of CNY3.5 billion is higher than China XD Plastics Co Ltd (B+/Stable) at CNY1.4 billion. Historical EBITDA margin is higher at 20%-25%, yet with lower visibility due to the evolving business mix as Tunghsu expands. FFO-adjusted net leverage is comparable to 'B+' peers at 2x-3x. Tunghsu's business profile is driven by its weaker non-listed segments and the stronger DXGD. The non-listed segments' profile is comparable to 'B' level peers, due to its weak market position, limited track record and lower business stability. DXGD's profile is comparable to Kangde Xin Composite Material Group Co., Ltd. (BB/Stable) due to its technology leadership, strong market position in a niche market, low cost base, and strategic alliance with customers. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: - Stable revenue and EBITDA margin for the non-listed high equipment business - DXGD's EBITDA growth of 25%, 55%, and 14% in 2017-2019 driven by glass substrates capacity expansion and contribution from newly acquired businesses - Dividend payout ratio to maintain 25% and 10% for DXGD and DXLT in 2017-2019 - Capital expenditure for DXGD and DXLT to be around CNY40 billion for 2017-2019 RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to Positive Rating Action - Material cash flows from listed entities to Tunghsu, including patent fees or dividends - FFO-adjusted net leverage to be sustained below 2x - FFO interest coverage to be sustained above 3x - Material improvements in its segment credit profile Future Developments That May, Individually or Collectively, Lead to Negative Rating Action - FFO-adjusted net leverage to be sustained above 3x - Non-listed segments' FFO-adjusted net leverage to be sustained above 5x - EBITDA margin to be sustained below 20% - FFO interest coverage to be sustained below 2x - Material deterioration in its segment credit profile LIQUIDITY Strong liquidity: Tunghsu Group's (after deconsolildating the listed and financing entities) undrawn credit facilities from banks amounted to CNY17.5 billion at end 2016. Tunghsu has sufficient liquidity to meet its short-term debt of CNY6.3 billion and investments in 2017. Contact: Primary Analyst Fiona Zhang Associate Director +852 2263 9909 Fitch (Hong Kong) Limited 19/F Man Yee Building 68 Des Voeux Road Central, Hong Kong Secondary Analyst Laura Zhai Director +852 2263 9974 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 Criteria for Rating Non-Financial Corporates (pub. 10 Mar 2017) here Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers (pub. 21 Nov 2016) here Additional Disclosures Dodd-Frank Rating Information Disclosure Form here Solicitation Status here#solicitation 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. 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