OREANDA-NEWS. S&P Global Ratings said today that it had lowered its long-term corporate credit rating on Zoomlion Heavy Industry Science and Technology Co. Ltd. to 'B' from 'B+'. The outlook is negative. At the same time, we lowered our long-term issue ratings to 'B' from 'B+' on the US$400 million 6.875% senior unsecured notes due 2017 and the US$600 million 6.125% senior unsecured notes due 2022 issued by Zoomlion H. K. SPV Co. Ltd. Zoomlion guarantees the notes. We are also lowering our long-term Greater China regional scale rating on the China-based machinery manufacturer and its guaranteed notes to 'cnB+' from 'cnBB-'.

"We downgraded Zoomlion because we expect the company's interest-serving capacity to deteriorate in the coming 12 months," said S&P Global Ratings credit analyst Stanley Chan. "In addition, Zoomlion's business profitability will likely weaken because of declining revenue from sluggish demand in the construction machinery sector and the company's high fixed-cost structure. The company's cost reduction efforts will partially offset the pressure on top line."

The likely deterioration in Zoomlion's interest-serving capacity underpins our negative rating outlook. We now expect the company's EBITDA interest coverage to decline to 0.7x-0.9x in the coming 24 months, compared with our previous forecast of 1.1x-1.2x. We do not see any clear signs that Zoomlion's debt leverage position will turn around.

The prospects of business recovery are slow and uncertain. Although the company's operating cash flow has been improving over the past four quarters, we estimate the amount will not be sufficient to fund ongoing business needs.

We forecast that Zoomlion's profitability will decline in the coming 12 months, with an EBITDA margin of 6%–7%, down from 7.6% in the first half of 2016. The company has been undergoing business restructuring and headcount reduction. However, with declining revenue, we believe the fixed costs remain relatively high and have eroded profitability.

We now project that the overall revenue for Zoomlion will continue to decline by 8%–10% over the coming 12 months, mainly because of the weak demand in China's construction machinery sector. We expect downstream customers to maintain prudent capital expenditure plans while the Chinese economy slows down. We expect more customers to opt for second-hand machinery with lower costs and to further postpone their machinery-replacement cycle. The decline in revenue from construction machinery should continue to offset growth in the environmental and agricultural machinery businesses.

Zoomlion withdrew in May 2016 its proposed offer to acquire Terex Corp., a U. S.-based lifting and material handling solutions company. In our opinion, the company will continue to engage in smaller-scale acquisitions of Chinese renminbi (RMB) 500 million–RMB600 million (US$75 million-US$ 90 million) and target agricultural - and environmental-related businesses. The company's acquisition appetite may put further pressure on its liquidity and refinancing.

We anticipate that Zoomlion has a clear plan to refinance its short-term maturing debt with longer tenors for onshore bonds, and to improve its liquidity. Although the company maintains decent relationships with policy banks and large state-owned banks in China, the refinancing and liquidity risks may escalate with any adverse changes in the currently favorable onshore credit environment. The slow deleveraging and Zoomlion's elevated debt level with little signs of improvement may lead to lenders turning more cautious in extending credit.

"The negative outlook reflects our expectation that Zoomlion's debt - and interest-serving capacity may deteriorate in the coming 12 months," said Mr. Chan.

We estimate that EBITDA interest coverage will stay below 1.0x and the debt-to-EBITDA ratio will remain above 25x without clear signs of improvement. Also, Zoomlion's large short-term maturities are vulnerable to any adverse changes in the currently favorable onshore credit conditions and the company's relationship with banks.

We may lower the ratings by one or more notches if Zoomlion's funding and liquidity pressure escalates and its debt maturity profile deteriorates. This could happen if: Working capital management and profitability are weaker than we expected; Debt-funded acquisitions are more aggressive than we anticipated; The weighted average debt maturity profile drops below two years; or The company's banking relationships weaken, reflected in higher borrowing costs and lower bank facilities from major lenders. Although not explicitly factored into the current rating, any large debt-funded acquisitions could weaken our current expectation for debt-servicing and the liquidity position.

We may revise the outlook to stable if Zoomlion's liquidity and funding improve and stabilize, while the company lengthens its debt maturity profile on a sustained basis. This could happen if Zoomlion:

Generates positive operating cash flows for early debt prepayment and continues to reduce its on - and off-balance-sheet exposure; Improves its capital structure and lengthens its weighted average debt maturity debt to substantially more than two years; and Materially improves its profitability and interest-servicing capacity, such that the EBITDA interest coverage is substantially higher than 2.0x for a prolonged period. Improves the ratio of sources of liquidity to uses of liquidity to more than 1.2x on a sustained basis.