Fitch Ratings has revised China Oriental Group Company Limited's outlook to negative from stable, following worse than expected deterioration in the company's operating environment. China Oriental's long term issuer default rating has been affirmed at BB+.
China Oriental's leverage, as measured by normalized working capital adjusted net debt or EBITDAR, may exceed 2 times, a negative rating threshold after the company announced a weak Q3 2012 performance that may extend into Q4 2012. Leverage was 1.6 times at end 2011. Profitability has been under pressure from volatile prices of steel products and steel raw materials this year. A weak demand environment has further constrained the ability of steel producers to pass on raw material price increases to their customers, resulting in thinning margins for China Oriental.
Deceleration in China's industrial production growth in the first eight months of 2012 has led to widespread demand weakness among steel using industries, including heavy equipment production, shipbuilding, rail locomotives, power equipment, and tractors. China's crude steel production grew only 2.3% over the same period, slightly better than the 2.1% growth in 2008 when crude steel production growth in China was at its slowest since the '80s.
Fitch, however, continues to believe that China Oriental can return to its previous profitability levels once prices of steel and its raw materials stabilize. Demand for steel continues to be underpinned by China's urbanization; production of steel rebar, which is used for construction, grew 15.9% in the first eight months of 2012. China Oriental's key steel product H section, which accounted for 52% of its self manufactured steel products gross profit in H1 2012, is used for infrastructure construction.
Negative: Future developments that may, individually or collectively, lead to negative rating action include:
Leverage as measured by normalized working capital adjusted net debt or EBITDAR above 1.5 times for two consecutive years or above 2 times in any single year
Further working capital increases without a corresponding increase in revenue
Significant weakening of China Oriental's strategic and operational ties with ArcelorMittal, one of its major shareholders
Positive: Future developments that may, individually or collectively, lead to positive rating action include:
Leverage below 1.5 times over the next 12 to 18 months. However, as the current Rating Outlook is Negative Fitch's sensitivities do not currently anticipate developments with a material likelihood, individually or collectively, of leading to a rating upgrade
Source - Fitch Ratings
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