(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 credit profile (SACP) to reflect our opinion of a "high" likelihood of timely and sufficient extraordinary support from the government of China (AA-/Stable/A-1+; cnAAA/cnA-1+) in the event of financial distress.
We consider Baosteel to be a government-related entity (GRE). The Chinese government owns 100% 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 extraordinary government 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 of production and technology. The company serves government policy in terms of meeting the domestic demand for steel and improving the level of product quality and technology of steel industry in China.
-- "Very strong" link with the government. The Chinese government, through SASAC, influences most 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 our expectation that the company is likely to demonstrate lackluster operating performances and to make increasing investments in 2012-2013, leading to weaker credit protection measures. The SACP also 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-end products, relatively low leverage, and strong liquidity. Baosteel's exposure to the highly cyclical, competitive, fragmented, and overcapacity nature of China's steel industry tempers the rating strengths. The company's plan to increase investment amid deteriorating steel industry condition adds to the weakness.
Baosteel's superior product mix enables the company to generate much higher profits than its domestic peers. The company's product portfolio has a higher share of high-end products compared with the national average (about 20% vs. national average of less than 10%). Most of these products are used in auto manufacturing, where Baosteel has a dominant share of the market. The company also has a lower-than-average share of low-end products (about 20% vs. national average of about 60-70%), most of which are used by the construction and infrastructure sectors. In our view, Baosteel's better product portfolio enables it to generate much higher profitability than domestic peers.
We believe Baosteel's relatively low leverage and strong liquidity allow it to endure the cyclical, competitive, and capital-intensive nature of the steel industry. We expect the company's ratio of total debt to total capital to be about 30% in 2012-2013. This is still a low level compared with peers, such as POSCO (A-/Negative/--), which should have a ratio of more than 35% over the same period. The ratio deteriorated from about 25% in 2010 and short-term debt concentration is high at close to 80%. We also expect the company to maintain its strong liquidity position. Basosteel has had a high level of cash and excellent access to capital markets, given its status as a GRE, with an important role to and very strong link with the 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 significant overcapacity. In our view, demand for steel in China is slowing down. It is unlikely to recover sharply, given weak property sector demand, delays in infrastructure spending, and slowing export industries. In addition, we expect the significant spare steel capacity andmarket fragmentation in China to lower the industry's overall profitability. Nevertheless, we see recent 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 the next 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 during the period. We expect Baosteel to continue to incur negative free operating cash flow and consequently increase its debt level during the expansion, given higher investments due to the capacity additions and reduced operating cash flow. However, we believe the newly built capacity could improve the company's market position in terms of capacity, product portfolio, costs and operating efficiency beyond the next three years.
Baosteel's overall liquidity is strong, in our view. Our base-case liquidity assessment includes the following assumptions:
-- We expect the company's sources of liquidity to be over 1.5x its uses of liquidity this year, even if EBITDA declines 15%.
-- Baosteel's sources of liquidity include cash and short-term investments of RMB56.1 billion as of the end of 2011, RMB22.6 billion in cash flow from operations, and the availability of unused credit lines.
-- The company's uses of liquidity include RMB26.7 billion in capital expenditure, RMB19.3 billion in current portion of long-term debt maturing within a year from the end of 2011, RMB5 billion in share repurchase and modest dividend distributions.
The stable outlook reflects our expectation that Baosteel will maintain its financial strength over the next 12-24 months despite a downturn in the steel industry, based on its good market position and focus on high-end products.
We may lower the ratings if we lower Baosteel's SACP to 'bb+' or below, which could be triggered by a significant deterioration of its financial risk profile. This could happen if the company's operating performance is weaker than currently expected due to slowing demand for steel, rising competition, and higher raw material costs, or if its capital spending is bigger than expected.
We may raise the ratings if we raise Baosteel's SACP to 'bbb+', which could be triggered by a debt-to-EBITDA ratio that is below 2.5x and a ratio of total debt to total capital that stays below 30% on a sustained basis. We believe the potential for an upgrade is limited in the next 12 months at least. Also, we may raise the rating if we raise the sovereign credit rating on China.