2017-07-01 13:19:00

Fitch Upgrades Wanhua Chemical to 'BBB'; Outlook Stable

Fitch Ratings-Hong Kong/Shanghai-14 June 2017: Fitch Ratings has upgraded China-based chemicals manufacturer Wanhua Chemical Group Co., Ltd's (Wanhua Chemical) Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDRs) to 'BBB' from 'BBB-'. The Outlook is Stable. The agency has also upgraded the company's senior unsecured rating to 'BBB' from 'BBB-' and the rating on the CNY1 billion 4.5% senior unsecured notes due 2017 issued by Wanhua Chemical International Holding Co., Ltd. to 'BBB' from 'BBB-'.

The upgrades are driven mainly by significant improvement in Wanhua Chemical's financial profile and business diversification, following the successful ramp-up of its Yantai operation. The Stable Outlook reflects our expectation that both Wanhua Chemical and its parent, Wanhua Industrial Group Co. Ltd (Wanhua Industrial, which owns 47.92% of Wanhua Chemical), will remain free cash flow (FCF) positive going forward. 

KEY RATING DRIVERS
Significant Financial Profile Improvement: Wanhua Chemical's financial metrics improved considerably in 2016, driven mostly by a price recovery in its non-methylene diphenyl di-isocyanate (MDI) business and the ramp-up of its petrochemical, functional and specialty chemical segments as it began production of petrochemicals at its Yantai plant. Revenue rose 54% yoy to CNY29.9 billion, of which MDI accounted for 43% (2015: 64%). Operating EBITDA margin increased to 31.2% in 2016 from 26.8% in 2015, as the new Yantai plant allows for higher vertical integration, which resulted in lower costs for its MDI production. 

As a result, Wanhua Chemical's FCF turned positive for the first time in 2016, and its FFO-adjusted net leverage dropped to 2.9x (FY15: 5.4x). This also resulted in parent Wanhua Industrial's strong performance as Wanhua Chemical accounted for 78% and 82% of Wanhua Industrial's revenue and operating EBITDA, respectively. We expect both Wanhua Chemical and Wanhua Industrial to maintain positive FCF generation going forward, on the back of strong EBITDA generation and capex discipline from 2018. We expect the company's operating EBITDA margin to remain around 22%-28% going forward, given the company's global leading position in the MDI sector, and a favourable market outlook. 

Greater Business Diversification: Wanhua Chemical's product mix also strengthened considerably in 2016 as its Yantai plant increased production, adding liquefied petroleum gas-based petrochemicals, such as propylene, propylene oxide, methyl tert-butyl ether and acrylic acid, as well as other high-margin specialty and functional chemicals such as aliphatic diisocyanates. Wanhua Chemical's gross profit contribution from MDI decreased to 61% in 2016 from 73% in 2015. We expect non-MDI segments to account for around 67% of Wanhua Chemical's revenue in 2017, compared with 57% in 2016. 

Leading Market Position Maintained: Wanhua Chemical continues to be the leading producer of MDI globally. Wanhua Chemical and Europe-based BorsodChem Zrt (BC), which is 100% owned by Wanhua Industrial, have total MDI capacity of 2.1 million tonnes, accounting for around 28% of total global capacity. The MDI market is highly concentrated, with the top five players accounting for around 80% of global capacity. 

DERIVATION SUMMARY
Wanhua Chemical's ratings are in line with BBB rated chemical peers such as Solvay SA (BBB/Stable) and Dow Chemical Company (BBB/Rating Watch Positive). It compares favourably with these peers in terms of EBITDA margin and leverage ratio, but weaker in terms of geographical and product diversification. 

KEY ASSUMPTIONS
Fitch's key assumptions within the rating case for Wanhua Chemical include:
- Operating EBITDA margin of 27.7% in 2017 and 25.3% in 2018
- Capex of around CNY6 billion in 2017, CNY4.9 billion in 2018 and CNY4.6 billion in 2019, in line with management's forecast
- Wanhua Industrial has no other major investments apart from investments in Wanhua Chemical and BC

RATING SENSITIVITIES
Negative: Future developments that may, individually or collectively, lead to negative rating action include:
- Loss of leading market position in core segments
- Failure to generate positive FCF on a sustained basis for both Wanhua Chemical and Wanhua Industrial
- Wanhua Industrial's FFO-adjusted net leverage sustained above 4.0x
- Wanhua Chemical's FFO-adjusted net leverage sustained above 3.0x
Positive: We do not envisage positive rating action in the next 12 to 18 months until both Wanhua Chemical and Wanhua Industrial demonstrate longer track records of sustained improvement in their financial performance, including sustained FCF generation and lower leverage levels.

LIQUIDITY
Wanhua Chemical's liquidity is well supported by its large unused banking facilities. As of end-2016, Wanhua Chemical had CNY2.0 billion in cash available and CNY29.8 billion in unused banking facilities, with short-term debt outstanding of CNY14.3 billion.