March 29, 2017 / 9:59 AM / 3 years ago

Fitch Upgrades Fufeng to 'BB+'; Outlook Stable

(The following statement was released by the rating agency) HONG KONG, March 29 (Fitch) Fitch Ratings has upgraded Fufeng Group Limited's Long-Term Foreign-Currency Issuer Default Rating (IDR) and senior unsecured rating to 'BB+' from 'BB'. The Outlook on the IDR is Stable. The upgrade reflects improved profitability and lower leverage. Fufeng's 2016 results also support the rating action, with improving performance in the amino acid segment that was helped by industry consolidation, a more efficient production process for the core monosodium glutamate (MSG) product, and increased contribution from other amino acid products. KEY RATING DRIVERS Lower MSG Production Costs: Fufeng is the largest producer of MSG globally and enjoys advantages, such as economies of scale, integrated facilities and proximity to raw materials, which competitors will find difficult to replicate. The company has been improving its MSG production process to reduce its unit cost per tonne over the next two to three years, further solidifying its competitiveness in the market. In addition, a policy shift in corn kernel pricing to a subsidy model has caused corn kernel prices to decline significantly in 4Q16. This benefits Fufeng as the cost of corn kernels account for 58% of its production cost of MSG. Growth from Amino Acid Products: The company expects amino acid products other than the core MSG product to drive sales growth and gross margin improvement. Sales of non-MSG products made up 43% of sales in the amino acid segment in 2016, up from 37% in 2015, and non-MSG products helped the gross margin in Fufeng's amino acid segment to expand by 6.5pp to 20.6% in 2016. The company intends to keep investing to improve the production process for its existing products and to launch new products each year, which should help to diversify its revenue stream and increase gross margin. Xanthan Gum Not A Concern: The profitability of Fufeng's xanthan gum segment has continued to weaken due to greater competition and overall weakness in the oil and gas industry, a key customer base. Gross margin for the segment has fallen to 15.9% in 2016 from a peak of 58.3% in 2013. Management has been focusing on orders with better profitability, but Fitch expects a muted outlook for the segment, which is likely to account for only 3% of gross profit (2015: 20%). Healthy Financial Profile: Fitch expects Fufeng's FFO to rise from higher sales and increased profitability from the amino acid segment, as well as improving efficiency in MSG production. Fitch estimates FCF may be negative in 2017-2018 due to investment in a new amino acid production facility, but the new capacity is likely to further diversify Fufeng's revenue stream away from MSG and increase profitability from an improving product mix. Net debt has been reduced to CNY1.7bn in 2016 from CNY2.8bn in 2015 and Fitch expects leverage to remain healthy. DERIVATION SUMMARY Fufeng's scale is in line with other 'BB' category peers, but its business profile is strong as it is the top global producer for MSG. The business profile should improve with diversification across amino acid products. Fufeng also has lower leverage relative to peers and FCF is likely to stay positive with lower capex requirements. The closest peer is China Lesso Group Holdings Limited (BB+/Stable), which, like Fufeng, is a dominant player in its commoditised industry. Fufeng and China Lesso both have low leverage and sustained FCF generation. However, China Lesso has a larger scale while Fufeng has better product diversification and higher profitability. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: - Amino acid segment: sales contribution from non-MSG products increasing gradually from 43% in 2016 to 47% in 2020; gross profit margin of 21.0% in 2016 improving to 21.8% by 2020 from improved MSG production efficiency and product mix improvement from non-MSG products - Xanthan gum segment: flat sales; gross profit margin of 15% in 2017-2020 (2016: 15.9%) - Capex: CNY1.8 billion a year in 2017-2018 and CNY1 billion a year from 2019 - Dividend payout: 20% of net profit from 2017-2018 and 40% from 2019 onward RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to Negative Rating Action - FFO-adjusted net leverage above 1.0x on a sustained basis (2015: 2.0x) after new production plant investment in 2017-2018 - Failure to generate positive FCF after new production plant investment in 2017-2018 - Sustained loss in MSG market share - Gross margin lower than 18% for a sustained period (2016: 20.4%) Future Developments That May, Individually or Collectively, Lead to Positive Rating Action - No positive rating action will be considered until Fufeng significantly increases its scale and improves its product diversification LIQUIDITY Sufficient Liquidity: Fufeng had CNY1.4 billion in readily available cash and over CNY3 billion in unutilised banking facilities, which can easily cover its short-term borrowings of CNY1.2 billion. The company has a CNY1 billion corporate bond and CNY975 million convertible bond maturing in 2018. Contact: Primary Analyst Cathy Chao Associate Director +852 2263 9967 Fitch (Hong Kong) Limited 19/F Man Yee Building 68 Des Voeux Road Central, Hong Kong Secondary Analyst Yee Man Chin Director +852 2263 9696 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 Additional Disclosures Dodd-Frank Rating Information Disclosure Form here _id=1021264 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. 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