(The following statement was released by the rating agency)
Oct 12 - =============================================================================== Summary analysis -- Baosteel Group Corp. -------------------------- 12-Oct-2012 =============================================================================== CREDIT RATING: A-/Stable/-- Country: China Primary SIC: Steel investment foundries =============================================================================== Credit Rating History: Local currency Foreign currency 11-Oct-2012 A-/-- A-/-- 20-Nov-2011 A/-- A/-- 23-Aug-2009 NR/-- NR/-- =============================================================================== Rationale
The ratings on Baosteel Group Corp. include two-notches uplift over the stand-alone creditprofile (SACP) to reflect our opinion of a "high" likelihood of timely and sufficientextraordinary support from the government of China (AA-/Stable/A-1+; cnAAA/cnA-1+) in the eventof financial distress.
We consider Baosteel to be a government-related entity (GRE). The Chinese government owns100% of the company through the State Assets Supervision and Administration Commission (SASAC).In accordance with our criteria for GREs, our view of a "high" likelihood of extraordinarygovernment support is based on our assessment of the following Baosteel characteristics:
-- "Important" role to the government. Baosteel is China's leading steel company in terms ofproduction and technology. The company serves government policy in terms of meeting the domesticdemand for steel and improving the level of product quality and technology of steel industry inChina.
-- "Very strong" link with the government. The Chinese government, through SASAC, influencesmost of Baosteel's important decisions and appoints the company's board and senior management.
We lowered Baosteel's SACP to 'bbb' from 'bbb+' on Oct. 11, 2012. The SACP reflects ourexpectation that the company is likely to demonstrate lackluster operating performances and tomake increasing investments in 2012-2013, leading to weaker credit protection measures. The SACPalso reflects the company's "satisfactory" business risk profile and its "intermediate"financial risk profile, as defined in our criteria.
Also, Baosteel's SACP reflects the company's strong market position, focus on high-endproducts, relatively low leverage, and strong liquidity. Baosteel's exposure to the highlycyclical, competitive, fragmented, and overcapacity nature of China's steel industry tempers therating strengths. The company's plan to increase investment amid deteriorating steel industrycondition adds to the weakness.
Baosteel's superior product mix enables the company to generate much higher profits than itsdomestic peers. The company's product portfolio has a higher share of high-end products comparedwith the national average (about 20% vs. national average of less than 10%). Most of theseproducts are used in auto manufacturing, where Baosteel has a dominant share of the market. Thecompany also has a lower-than-average share of low-end products (about 20% vs. national averageof about 60-70%), most of which are used by the construction and infrastructure sectors. In ourview, Baosteel's better product portfolio enables it to generate much higher profitability thandomestic peers.
We believe Baosteel's relatively low leverage and strong liquidity allow it to endure thecyclical, competitive, and capital-intensive nature of the steel industry. We expect thecompany's ratio of total debt to total capital to be about 30% in 2012-2013. This is still a lowlevel compared with peers, such as POSCO (A-/Negative/--), which should have a ratioof more than 35% over the same period. The ratio deteriorated from about 25% in 2010 andshort-term debt concentration is high at close to 80%. We also expect the company to maintainits strong liquidity position. Basosteel has had a high level of cash and excellent access tocapital markets, given its status as a GRE, with an important role to and very strong link withthe Chinese government.
However, we believe the steel industry's fundamentals in the region, especially in China,are likely to remain weak over the next 12-18 months, given slowing demand amid significantovercapacity. In our view, demand for steel in China is slowing down. It is unlikely to recoversharply, given weak property sector demand, delays in infrastructure spending, and slowingexport industries. In addition, we expect the significant spare steel capacity andmarketfragmentation in China to lower the industry's overall profitability. Nevertheless, we seerecent signs that companies are making voluntary production cuts to cope with lackluster demand.
In our view, Baosteel's steel capacity expansion could weaken its credit quality over thenext two years. The company is likely to add 10 million tons of annual capacity in Zhanjiang,Guangdong province, over the next three to five years and will increase its investment duringthe period. We expect Baosteel to continue to incur negative free operating cash flow andconsequently increase its debt level during the expansion, given higher investments due to thecapacity additions and reduced operating cash flow. However, we believe the newly built capacitycould improve the company's market position in terms of capacity, product portfolio, costs andoperating efficiency beyond the next three years.
Baosteel's overall liquidity is strong, in our view. Our base-case liquidity assessmentincludes the following assumptions:
-- We expect the company's sources of liquidity to be over 1.5x its uses of liquidity thisyear, even if EBITDA declines 15%.
-- Baosteel's sources of liquidity include cash and short-term investments of RMB56.1billion as of the end of 2011, RMB22.6 billion in cash flow from operations, and theavailability of unused credit lines.
-- The company's uses of liquidity include RMB26.7 billion in capital expenditure, RMB19.3billion in current portion of long-term debt maturing within a year from the end of 2011, RMB5billion in share repurchase and modest dividend distributions.
The stable outlook reflects our expectation that Baosteel will maintain its financialstrength over the next 12-24 months despite a downturn in the steel industry, based on its goodmarket position and focus on high-end products.
We may lower the ratings if we lower Baosteel's SACP to 'bb+' or below, which could betriggered by a significant deterioration of its financial risk profile. This could happen if thecompany's operating performance is weaker than currently expected due to slowing demand forsteel, rising competition, and higher raw material costs, or if its capital spending is biggerthan expected.
We may raise the ratings if we raise Baosteel's SACP to 'bbb+', which could be triggered bya debt-to-EBITDA ratio that is below 2.5x and a ratio of total debt to total capital that staysbelow 30% on a sustained basis. We believe the potential for an upgrade is limited in the next12 months at least. Also, we may raise the rating if we raise the sovereign credit rating onChina.