December 16, 2016 / 3:43 AM / 2 years ago

Fitch Assigns China Grand Auto's Senior Perpetual Securities Final 'B+'

(The following statement was released by the rating agency) HONG KONG, December 15 (Fitch) Fitch Ratings has assigned Baoxin Auto Finance I Limited's (Baoxin Finance) US dollar-denominated senior perpetual securities a final rating of 'B+' and Recovery Rating of 'RR4'. Baoxin Finance is 100% owned by Baoxin Auto Group Limited, which is 75% owned by China Grand Automotive Services Co., Ltd (China Grand Auto, BB-/Stable). The securities are unconditionally and irrevocably guaranteed by China Grand Auto. The senior perpetual securities are rated one notch below China Grand Auto's 'BB-' senior unsecured rating in accordance with Fitch's "Treatment and Notching of Hybrids in Non-Financial Corporate and REIT Credit Analysis" criteria. This one-notch difference reflects the securities' coupon deferral feature. Fitch expects to accord no equity credit to the securities in its evaluation of China Grand Auto's capital structure and leverage as this instrument ranks pari passu with the company's senior unsecured obligations. The final rating follows the receipt of documents conforming to information already received and is in line with the expected rating assigned on 6 November 2016. On 16 December 2016, China Grand Auto announced a proposed tap of the senior perpetual securities. This does not affect the rating of the issue. KEY RATING DRIVERS Large Scale, Strong Market Position: China Grand Auto's ratings are supported by its large operating scale and leading market position. The company is the largest auto dealership in China, with more than 600 outlets in 27 provinces, covering more than 50 brands. China Grand Auto has been a consolidator in the market and the recent of acquisition of Baoxin Auto further expanded China Grand Auto's offerings in the luxury car segment. Fitch expects the auto dealer's strong brand and geographical diversification to reduce earnings volatility. In addition, the large operating scale allows China Grand Auto to more efficiently use its store network to develop new revenue sources, such as its used-car sales platform. Robust Long-Term Prospects: China is the largest passenger vehicle market in the world. Despite the deceleration in growth, the long-term growth drivers for passenger vehicles remain intact, given low vehicle ownership penetration and density. Fitch expects passenger vehicle sales to grow in the mid-single-digit percentages over the medium term, a pace that is healthy and higher than the developed-market average. In addition to a solid outlook for new-car sales, Fitch expects increasing revenue contribution from other segments, including after-sales services, commission income, leasing, and used-car sales. Used-car sales are at a nascent stage in China, but have substantial growth potential in the next 5-10 years due to increasing car ownership, changing consumer behaviour, and favourable policy. Competitive Industry, Weak Bargaining Power: China's auto dealership industry is highly fragmented and competitive. Although China Grand Auto is the largest dealership in China, it has only 3%-4% market share by sales volume across the country. Margins are low for the whole industry due to dealers' weak bargaining power and a regulatory environment that favours automakers over dealers. However, we do not expect dealer margins to substantially deteriorate from current levels because automakers and dealers are dependent on each other. Chinese auto dealers generally have EBITDA margins in the low to mid-single digits, which is comparable to peers in the US. High Leverage Constrains Ratings: China Grand Auto's financial leverage is high after acquiring Baoxin. The dealer's FFO-adjusted net leverage was 6x and net debt to EBITDA was 4.7x at end-2015 (pro-forma Baoxin, excluding leasing subsidiary). China Grand Auto's board has approved an equity placement plan to raise up to CNY8bn, which is still pending regulatory approval. If the equity placement is successful, Fitch estimates that FFO-adjusted net leverage may drop to a healthier level of below 4x. China Grand Auto is an acquisitive company and has expanded by acquiring smaller car dealers over the last few years. The company views the current market downturn as an opportunity to consolidate the industry, thus further M&A are possible. Excluding M&A, Fitch expects China Grand Auto to generate FCF margin of around 1% over the next few years, which will allow gradual deleveraging. Leasing Subsidiary Deconsolidated: China Grand Auto carries out auto leasing services via its leasing subsidiary, Huitong Xincheng. Fitch has deconsolidated Huitong Xincheng for the purpose of our analysis. Huitong Xincheng had a debt-to-equity ratio of 1.5x at the end of 2015, which we view as adequate. No Linkage to Xinjiang Guanghui: China Grand Auto's largest shareholder is Xinjiang Guanghui Industry Investment (Group)., Ltd (Xinjiang Guanghui), which owns a 37% stake. Although Xinjiang Guanghui's credit profile is weak, Fitch has not linked China Grand Auto's ratings to Xinjiang Guanghui for several reasons: -- China Grand Auto is separately listed and Xinjiang Guanghui cannot easily access China Grand Auto's cash flows except via dividends; -- The management team is separate, and only two out of nine of China Grand Auto's board members are affiliated with Xinjiang Guanghui; -- China Grand Auto has many institutional shareholders; and -- Xinjiang Guanghui has pledged a large portion of its shares in China Grand Auto, further reducing its influence on China Grand Auto KEY ASSUMPTIONS Fitch's key assumptions within our rating case for China Grand Auto include: - Mid to high single-digit revenue growth in new car sales, mainly driven by store additions, over 2016-18 - Consolidated EBITDA margin of 4%-5% over 2016-18 - Maintenance capex at 1%-1.5% of revenues over 2016-18 - No common dividends RATING SENSITIVITIES Positive: Future developments that may, individually or collectively, lead to positive rating action include: - FFO-adjusted net leverage (excluding leasing subsidiary) sustained below 3.5x Negative: Future developments that may, individually or collectively, lead to negative rating action include: - Sustained decline in market share and/or revenues - FFO-adjusted net leverage (excluding leasing) sustained above 5x (2016E: 5.3x) - FFO fixed-charge coverage sustained below 2x (2016E: 2.1x) - EBITDA margin sustained below 3.5% (2016E: 4.5%) Contact: Primary Analyst Yee Man Chin Director +852 2263 9696 Fitch (Hong Kong) Limited 19F, Man Yee Building 68 Des Voeux Road Central, Hong Kong Secondary Analyst Fiona Zhang Associate Director +852 2263 9909 Committee Chairperson Kalai Pillay Senior Director +65 6796 7221 Date of Relevant Rating Committee: 3 November 2016 Summary of Financial Statement Adjustments - Leasing Entity Deconsolidated: Fitch has deconsolidated Huitong Xincheng, the 100% owned subsidiary of China Grand Auto Media Relations: Wai-Lun Wan, Hong Kong, Tel: +852 2263 9935, Email: Additional information is available on Applicable Criteria Criteria for Rating Non-Financial Corporates (pub. 27 Sep 2016) here Treatment and Notching of Hybrids in Non-Financial Corporate and REIT Credit Analysis (pub. 29 Feb 2016) here Additional Disclosures Solicitation Status here Endorsement Policy here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. 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