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Shanghai Huayi (Group) Co. Outlook Revised To Stable On Improved Financial Leverage; ‘BBB-‘ Rating Affirmed

          HONG KONG (S&P Global Ratings) Sept. 29, 2017--S&P Global Ratings today revised its rating outlook on Shanghai Huayi (Group) Co. to stable from negative. At the same time, we affirmed the 'BBB-' long-term corporate credit rating on the China-based chemicals and tire producer.
           We revised the outlook to stable because we expect Shanghai Huayi's financial leverage to improve in 2017 and remain at a similar level in the coming one to two years as a result of a recovery in the chemicals industry. 
          The Chinese chemicals industry has sustained a recovery that began in the fourth quarter of 2016, driven by environmental protection-related production cuts across the industry, and a recovery in commodities prices such as coal and oil. In our view, both central and local governments' stricter environmental-protection monitoring has restricted production by medium- to small-sized chemical companies and postponed scheduled ramp-ups of new capacity. The supply limits have supported higher prices. 
          Large-scale chemical producers such as Shanghai Huayi that meet high environmental protection standards benefit from price increases related to supply curbs. We also expect the company's enlarged capacity and expansion into higher-value fine chemicals to support its profitability. Accordingly, we see low risk that the company's profitability will drop materially to levels similar to the trough during 2014-2015, despite our expectation that GDP growth will slow down in China. 
          We expect better profitability and operating cash flows to keep Shanghai Huayi's debt-to-EBITDA ratio in a range of 4x-5x in the coming 12-24 months, lower than our previous expectation of over 5x. At the same time, based on rising EBITDA, we anticipate the company's EBITDA interest coverage to increase to well above 3x in the same period. This is despite higher capital spending, which will lead to slightly higher outstanding debt in 2017-2018. 
          The company's capital expenditure in 2016 was much lower than planned due to slower-than-expected capacity expansion. As such we believe capital expenditure in 2017 to 2018 is likely to increase again, however we believe the company could fund part of the spending by its operating cash and thus cap its debt growth. 
          We affirmed the ratings despite the recent improvement, because the company's profitability is still weak and volatile relative to peers', and its high debt leverage continues to constrain the ratings. These weaknesses are offset by the company's diverse product portfolio, established domestic market position, adequate technology capability, and moderately high likelihood of extraordinary government support in the case of distress. 
          The stable outlook reflects our view that Shanghai Huayi's debt-to-EBITDA ratio will stay comfortably within a 4x-5x range in the coming 12-24 months and its EBITDA interest coverage will sustain above 2x during the same period because of improving industry conditions. 
          We may lower the rating if Shanghai Huayi's financial leverage increases beyond our expectation due to worsened profitability or higher-than-expected capital expenditure, leading to EBITDA interest coverage consistently lower than 2x. That could happen if the chemicals industry again faces overcapacity, fierce competition, or sustained high raw material prices. 
          We could also downgrade the company if we lower our assessment on the creditworthiness of the Shanghai municipal government or we believe the company's link to the government has weakened. 
          We could upgrade our rating on Shanghai Huayi rating if the company realizes material improvements in its performance and reduces its financial leverage so that the debt-to-EBITDA ratio stay consistently below 3x. Attaining such ratios would require a sustainable improvement in industry conditions and a substantial growth in Shanghai Huayi's sales of high value-added fine chemicals such that the company can significantly enhance its EBITDA margin. We think this is a rather remote scenario in the next 12-24 months, given the company still has capacity expansion plans that require debt financing and the recovery of chemicals industry could be hindered by a slowing economy in China. 
          We could also upgrade Shanghai Huayi's rating if we believe the likelihood of extraordinary government support will strengthen.