October 28, 2016 / 7:16 AM / 3 years ago

Fitch Affirms Fufeng Group at 'BB'; Outlook Stable

(The following statement was released by the rating agency) HONG KONG, October 28 (Fitch) Fitch Ratings has affirmed China-based monosodium glutamate (MSG) and xanthan gum producer Fufeng Group Limited's (Fufeng) Long-Term Issuer Default Rating (IDR) and senior unsecured rating at 'BB'. The Outlook for the IDR is Stable. The company's 'BB' rating reflects improving performance in the amino acid segment that is supported by industry consolidation, a more efficient production process, and increased contribution from other amino acid products apart from the core MSG product. Fitch expects Fufeng's free cash flow to continue to be positive and capex to remain stable, which should result in a decline in leverage. KEY RATING DRIVERS Beneficiary of Industry Consolidation: Fufeng is the largest producer of MSG globally and enjoys advantages, including economies of scale, integrated facilities and proximity to raw materials, that are difficult to replicate. In addition, Fufeng has been investing to improve its MSG production process to reduce its unit cost per tonne over the next two to three years, which will strengthen its competitiveness and allow for gross margin expansion. Thus, management expects smaller players to exit the market as it becomes increasingly difficult for them to offer competitive pricing while staying profitable. Fufeng's gross margin for the amino acid segment in 1H16 rose by 3.2pp to 19.5% from 2015. Higher Contribution from Other Products: Fitch expects higher sales of amino acid products other than the core MSG product to drive overall sales growth and improvement in gross margin. Non-MSG products accounted for 41% of amino-acid segment sales in 1H16, compared with 37% in 2015. The company intends to continue investing to improve the production process for existing products and to launch new products each year, which should help to diversify its revenue stream and increase gross margin. Xanthan Gum Remains Weak: Fitch expects profitability of the xanthan gum segment to remain weak due to more intense competition and overall weakness in the oil and gas industry. Gross margin for the segment fell to 36.6% in 2015 from a peak of 58.3% in 2013, and further deteriorated to 15.6% in 1H16. Fitch expects xanthan gum to contribute only 5%-6% of gross profit in the future (2015: 20%). Deleveraging from Higher FFO: Fitch expects Fufeng's FFO to rise as higher sales and increased profitability from the amino acid segment offsets the weaker showing in the xanthan gum segment. The company expects capex to remain stable at no more than CNY1.0bn annually, including investments in MSG production technology and new amino acid products. Fitch expects Fufeng to remain FCF positive from 2016 onwards after turning positive in 2015 (2015: CNY80m). Fitch expects FFO-adjusted net leverage to continue to decrease gradually from 2.2x in 2015 to 2.0x in 2016 and 1.7x in 2017. KEY ASSUMPTIONS Fitch's key assumptions within the rating case for the issuer include: - Gross margin of 19.0%-19.6% in the MSG segment in 2016-19 - Gross margin of 16.0% in the xanthan gum segment in 2016, gradually increasing to 18.0% by 2017 - Capex of CNY1.0bn in 2016 and CNY800m from 2017 RATING SENSITIVITIES Positive: Future developments that may, individually or collectively, lead to positive rating action include: - FFO-adjusted net leverage below 1.0x on a sustained basis - Evidence Fufeng can sustain pricing power over several years - Sales contribution from non-MSG amino acid products of over 50% (1H16: 41%) Negative: Future developments that may, individually or collectively, lead to negative rating action include: - FFO-adjusted net leverage above 2.5x on a sustained basis - Sustained negative free cash flow - MSG gross profit per tonne below CNY1,000 -Sustained loss of market share in the MSG business Contact: Primary Analyst Yee Man Chin Director +852 2263 9696 Fitch (Hong Kong) Limited 19F, Man Yee Building 68 Des Voeux Road Central, Hong Kong Secondary Analyst Yi Zhang Analyst +86 21 5097 3390 Committee Chairperson Kalai Pillay Senior Director +65 6796 7221 Media Relations: Wai-Lun Wan, Hong Kong, Tel: +852 2263 9935, Email: wailun.wan@fitchratings.com. 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