OREANDA-NEWS. Fitch Ratings has affirmed China XD Plastics Co Ltd's (XD Plastics) Long-Term Foreign-Currency Issuer Default Rating (IDR) at 'B+', reflecting the company's trend towards improved leverage, which peaked in 2016, and limited refinancing risk. The Outlook is Stable.

Fitch has also upgraded the senior unsecured rating to 'B+' from 'B' and Recovery Rating to 'RR4' from 'RR5'. At the same time, Fitch has withdrawn the rating for XD Plastics' US dollar offshore bond due February 2019 of 'B', issued by its wholly owned subsidiary, Favor Sea Limited, as the company called the entire outstanding bond on 29 August 2016.

KEY RATING DRIVERS

Margin Continues to Erode: XD Plastics' operating EBITDA margin remains on a downward trend. Its operating EBITDA margin edged down to 17.5% yoy in 1H16, from 18.1% in 1H15, primarily due to ongoing falling average selling prices. However, the price fall was at a slower pace in 1H16, dropping 6% yoy compared with an 8% decline yoy in 2015. We expect XD Plastics' profitability to continue eroding yoy in 2016 and 2017 due to weak terminal demand amid rising raw material costs.

Rising Inventory Days: XD Plastics' cash conversion cycle has been extending since 2014, primarily driven by lengthening inventory days. Average inventory days rose to 165 days in 1H16, from 132 days at end-2015. The company says this is part of its strategy to purchase more raw materials while prices are low and support the operations of its new Sichuan plant. However, the company was able to cut account receivable days, which partially offset the inventory day hike. Average account receivable days decreased to 81 days in 1H16, from 86 days at end-2015.

Liquidity to Improve in 2017: We expect XD Plastics' liquidity to tighten slightly in 2016 due to the large increase in its inventory and USD150m payment to call its entire offshore US dollar bond. However, we expect the company's liquidity position to strengthen from 2017, as its access to refinancing appears to have improved. This was demonstrated by XD Plastics' successful raising of a USD180m syndicate loan in August 2016 to fund the offshore bond call. In addition, we expect the company's Sichuan project to considerably enhance its cash generation, with a large cut in capex.

Deleveraging Expected in 2017: We expect XD Plastics to see its FFO-adjusted net leverage to drop to 2.3x in 2017, from 3.6x in 2016, mainly due the significant operating EBITDA contribution from the Sichuan plant and capex cuts from 2017. The company's capex dropped 68% yoy to USD40m in 1H16. We believe the Sichuan plan's operation, which started on 7 July 2016, are on track and expect the company's operating EBITDA to rise 36.6% yoy to USD239m in 2017, from USD175m in 2016. The net leverage hike in 2016 is primarily due to weaker top line growth, longer inventory days and heavy capex.

KEY ASSUMPTIONS

- Sichuan projects on track

- Unlimited access to refinancing

- Considerable capex cut from 2017

RATING SENSITIVITIES

Negative: Future developments that may, individually or collectively, lead to negative rating action include:

- FFO-adjusted net leverage sustained above 3x

- operating EBITDA margin sustained below 12%

- significantly worsening liquidity position.

Positives: Future developments that may, individually or collectively, lead to positive rating action include:

- operating EBITDA margin stability and sustained above 20%

- FFO-adjusted net leverage sustained below 2x

- improved customer and geographic diversification