Fitch Confirms Shanghai Huayi at ‘BBB-‘; Stable outlook

Fitch Ratings has confirmed the Chinese chemical company Shanghai Huayi Company (Group) (Huayi) Long Term Issuer Default Rating (IDR) and Senior Unsecured Rating at ‘BBB-‘.

The outlook on the IDR is stable.

Huayi is 100% owned by Shanghai State Corporation Heritage Supervision and Administration Commission (Shanghai SASAC). Ratings are assessed on four factors under Fitch’s Government-Related Entity (GRE) Rating Criteria, resulting in a two-notch increase in the Standalone Credit Profile (SCP) of ‘bb’.

The stable outlook reflects our expectation that government support will remain strong and that Huayi’s operations will remain stable, with net leverage remaining above 2.5x over the 2022-2025 period.

Main rating factors

“Strong” State Control and Support: Fitch assesses the status, ownership and control of Huayi by the Shanghai government as “Strong” because the company is strategically important to the city as the only chemical company owned by Shanghai SASAC. Huayi remains 100% owned by Shanghai SASAC. It undertakes scientific research projects in advanced materials for sectors such as national defence, jumbo jets and alternative energies.

Shanghai SASAC has provided constant support to Huayi in the form of direct grants and capital injections, especially for R&D in specific chemical projects. Fitch expects support to continue and therefore we have rated the support record and expectation factor at “Strong”.

‘Moderate’ impact on funding: Fitch rates the financial implications of a Huayi default as ‘moderate’ because Huayi is an active domestic bond issuer, but the size of the company is moderate compared to others . Shanghai public enterprises (EP). A default by Huayi would only have a moderate impact on access to the funding market for other Shanghai state-owned companies. However, Fitch rates the social and political impact of a default by Huayi as “low”, as the company operates in a highly competitive market with a large number of rivals and substitutes.

Strong link with the subsidiary: Fitch fully consolidates the A-share listed partner 41.99% owned by Huayi, Shanghai Huayi Group Corporation Limited (shanghai huayi), in its analysis, given the lack of legal closure and Huayi’s absolute control over the listco under our criteria for assessing the links between parent companies and subsidiaries. This is evident from the fact that Huayi and its subsidiaries have significant deposits placed with, and borrowings from, shanghai huayi financial company, which acts as the centralized treasury of Huayi. Huayi and its subsidiaries as well as shanghai huayi also supply each other with raw materials.

Stable leverage, increasing scale: Fitch expects Huayi’s net leverage (net debt/EBITDA) to increase to 2.6x in 2022 (2021: 1.9x). This is due to high capital expenditure, the impact on revenue from the Covid-19 related lockdown in Shanghai and partially offset by higher average chemical selling prices, which we expect to decline over the next few years in line with our oil and gas price assumptions.

We expect capital expenditure to remain elevated at around 7 to 10 billion CNY over 2022-2023 as Huayi pursues Phase II of the Guangxi project, focused on new materials and fine chemicals. New project launches mean we expect the business to benefit from increasing scale and stable margins through the addition of high value products.

Derivation Summary

Fitch uses a bottom-up approach to evaluate Huayi against our GRE criteria, which is based on the SCP of “bb” plus a two-notch increase to “BBB-”, reflecting potential support from ultimate parent company, Shanghai SASAC. The two-notch upswing is similar to that between other GREs and their government relatives, such as Shanghai Construction Group Co., Ltd. (BBB+/Stable).

Huayi has shown higher cash flow volatility than other high-grade chemical issuers due to its high exposure to the commodity chemicals sector. His ‘bb’ SCP is online with Methanex Corp. (BB/Positive), which is the world’s largest supplier of methanol. Methanex has a strong business profile due to its geographical diversification and low costs, and its leverage has also been lower than that of Huayi in recent years. Huayi’s SCP is one notch lower than the “BB+” rating of its global chemical peers, such as Tata Chemicals Limited (BB+/Stable), which is more geographically diversified and exhibits less earnings and leverage volatility.

Key assumptions

Fitch’s main assumptions in our rating file for the issuer:

Revenue increase of 16.3% in 2022, followed by minimal growth over 2023-2024 and a decline of 5.7% in 2025;

Operating EBITDA margin of around 15% in 2022, gradually decreasing to 12% in 2025;

Annual investments of 10 billion yuan in 2022 followed by 6 to 7 billion CNY one year in 2023-2025;

No acquisitions over 2022-2025.

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to positive rating action/improvement:

Increased likelihood of support from the Shanghai government;

Net leverage of funds from operations (FFO) below 3.0x on a sustainable basis;

Net debt/EBITDA less than 2.5x on a sustainable basis.

Factors that could, individually or collectively, lead to a negative rating action/downgrade:

Weakening of ties with SASAC in Shanghai;

Net FFO leverage greater than 4.0x on a sustainable basis;

Net debt/EBITDA above 3.5x on a sustainable basis.

Best/Worst Case Evaluation Scenario

International credit ratings of non-financial corporate issuers have a best-case scenario for a rating upgrade (defined as the 99th percentile of rating transitions, measured in the positive direction) of three notches over a rating horizon three years; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured negatively) of four notches over three years. The full range of best-case and worst-case credit ratings for all rating categories ranges from ‘AAA‘ to ‘D’. Worst case and worst case credit ratings are based on historical performance. For more information on the methodology used to determine industry-specific best-case and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.

Liquidity and debt structure

Adequate liquidity: Huayi had 13.6 billion yuan available cash at the end of 2021, versus 14.1 billion yuan short-term debt. In addition, it also had unused bank facilities of more than 80 billion yuan. However, these facilities are uncommitted as committed facilities are rare in the Chinese banking industry.

Issuer profile

Huayi is a medium-sized state-owned chemical enterprise with highly diversified products. It is the largest methanol producer in eastern China and one of the three largest producers of acetic acid products in China. More than 90% of its total turnover comes from Chinawith the rest of Thailand.

REFERENCES FOR A MOSTLY MATERIAL SOURCE CITED AS A KEY SCORING FACTOR

The main sources of information used in the analysis are described in the applicable criteria.

ESG considerations

Unless otherwise specified in this section, the highest level of ESG credit materiality is a score of “3”. This means that ESG issues are credit-neutral or have minimal impact on the entity’s credit, either because of their nature or the way they are managed by the entity. For more information on Fitch’s ESG materiality scores, visit www.fitchratings.com/esg