December 1, 2017 / 9:00 AM / 10 months ago

Fitch Upgrades Tewoo to 'BBB' on Stronger Linkage; Outlook Stable

(The following statement was released by the rating agency) HONG KONG/SHANGHAI, December 01 (Fitch) Fitch Ratings has upgraded leading Chinese commodity trader Tewoo Group Co., Ltd.'s Long-Term Foreign-Currency Issuer Default Rating (IDR) and senior unsecured rating to 'BBB' from 'BBB-'. The Outlook is Stable. A full list of rating actions is at the end of this commentary. The upgrade reflects Fitch's belief that Tewoo's linkage with Tianjin municipality is stronger than previously thought. As such, we have increased the uplift from Tewoo's standalone 'BB' rating to three notches from two notches using a bottom-up approach under our Parent Subsidiary Rating Linkage Criteria. Tewoo's strategic importance to the Tianjin government is reflected by its position as northern China's largest commodity trader. KEY RATING DRIVERS Stronger Linkages to Tianjin: We have increased our assessment of Tewoo's strategic importance to Tianjin State-Owned Asset Supervision and Administration Commission (SASAC) in light of its dominant position in commodity trading and its role of maintaining Tianjin's status as northern China's largest trading hub. Tewoo's trading business, which spans across the Bohai Economic Rim, supports the region's pillar state-owned enterprises operating in infrastructure, steel, manufacturing and auto industries. Its high trading volume makes it Tianjin's largest non-bank tax contributor and it is the municipality's only Fortune Global 500 company. Tewoo's failure would pose significant reputational risk to Tianjin. Dominant Market Position: Fully owned by Tianjin SASAC, Tewoo is China's largest commodity and metals trading company by total revenue and volume traded in ferrous and non-ferrous metals and coal products. Its trading volume in iron ore was about 5.3x that of the second-ranking trader in 1H17, or 20% of China's imported iron ore volume during the period. Stability from Agency Trading: Agency trading, where Tewoo passes on pricing and forex risks to counterparties, comprises more than 70% of Tewoo's business. This helps stabilise Tewoo's gross profit margin. We expect Tewoo's gross profit margin to remain low at 2.0% and operating EBITDA at 1.6%-1.7% after eliminating foreign-exchange fluctuations. Tewoo is expanding into higher-margin segments, including logistics and financial services, to enhance its profitability. Lower Leverage in 2018: Fitch expects Tewoo's revenue growth to slow from 2017 due to decreased demand for metals and iron ore. Coupled with low capex requirements, Tewoo's FFO adjusted net leverage is likely to improve to 4.0x by 2019 (2016: 4.8x). Tewoo relied on debt to support expansion in 2013-2016, during which time its FFO adjusted net leverage increased from 3.7x and its revenue rose to CNY421 billion, from CNY338 billion. Tewoo has been free cash flow positive since 2013 due to sound working-capital management. Tewoo's FFO fixed-charge coverage ratio was just over 1.3x in 2016, which is low for its rating level. Nonetheless, We expect the company to report a ratio of 1.1x in 2017 and 1.5x in 2018 Sector and Customer Concentration: More than 73% of Tewoo's revenue and 56% of gross profit were generated from metals and ore trading in 2016, leaving the trader heavily dependent on the health of China's ferrous metals industry. Tewoo's expansion into the financial, logistic and auto trading sectors should mitigate its sector concentration risk. Other main business accounted for 5% and 22% of total revenue and gross profit in 2016. We do not expect this to change in the next 12-18 months. Tewoo has moderate customer concentration risk, with the top-10 customers accounting for 19% of revenue from metals, 16% from ore and 38% from energy trading in 1H17. DERIVATION SUMMARY Tewoo has higher gross revenue but a lower operating EBITDAR margin than Bunge Limited (BBB/Negative) and Tereos Union de Cooperatives Agricoles a Capital Variable (BB/Stable). Tewoo has a similar leverage ratio to Tereos, but higher than that of Bunge. Tewoo's FFO fixed-charge coverage is lower than that of peers, but the ratio is skewed as it does not account for interest received from the large amount of cash on the trader's balance sheet. Tewoo has generated positive free cash flow since 2013, unlike its rated peers, despite significant commodity price turmoil. Tewoo's rating benefits from a three-notch uplift from Tianjin SASAC from its standalone rating. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: - Revenue growth of 4%-8% per annum during 2017-2020 (2016: 4%), stable gross profit margin of 2% (2016: 2.1%) and EBITDA margin of 1.6%-1.7% (2016: 1.5%), after foreign-exchange fluctuations - Agency trading to comprise of 75% or more of total business volume - Lower working capital requirement in 2017-2018 - Stable capex of CNY450-500 million per annum during 2017-2020 RATING SENSITIVITIES Developments that May, Individually or Collectively, Lead to Positive Rating Action - Significant improvement in business scale, margins and diversification - EBITDA/net interest sustained above 5.0x - FFO net leverage sustained below 3.5x - Strengthened linkages between Tianjin SASAC and Tewoo Developments that May, Individually or Collectively, Lead to Negative Rating Action - Shrinking business scale that results in falling revenue - EBITDA margin below 1% for a sustained period - EBITDA/net interest below 1.5x for a sustained period - FFO net leverage above 4.5x for a sustained period - Weakened linkages between Tianjin SASAC and Tewoo LIQUIDITY Adequate Liquidity: Tewoo had short-term debt of CNY50.7 billion, long-term debt of CNY33.0 billion - including its CNY2.0 billion perpetual bond - and unrestricted cash of CNY53.3 billion as of 1H17. The trader also has an unused credit facility of CNY42.5 billion, which is adequate to finance its short term debt. FULL LIST OF RATING ACTIONS Tewoo Group Co., Ltd. - Long-Term IDR upgraded to 'BBB' from 'BBB-'; Outlook Stable - Senior unsecured rating upgraded to 'BBB' from 'BBB-' Tewoo Group Finance No 2 Limited - USD300 million 4.5% senior unsecured notes due 2019 upgraded to 'BBB' from 'BBB-' Tewoo Group Finance No 3 Limited - USD300 million 4.625% senior unsecured notes due 2020 upgraded to 'BBB' from 'BBB-' - USD200 million 5.5% senior unsecured notes due 2022 upgraded to 'BBB' from 'BBB-' Contact: Primary Analyst Edwin Fan Director +852 2263 9958 Fitch (Hong Kong) Limited 19/F Man Yee Building 68 Des Voeux Road Central, Hong Kong Secondary Analyst Charles Li Analyst +86 21 5097 3016 Committee Chairperson Su Aik Lim Senior Director +852 2263 9914 Summary of Financial Statement Adjustments: Tewoo classifies perpetual bonds as equity. Fitch treats perpetual bonds as 100% debt. 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