OREANDA-NEWS. Fitch ratings has downgraded Zoomlion Heavy Industry Science and Technology Co. Ltd's (Zoomlion) Long-Term Issuer Default Rating (IDR) to 'BB' from 'BB+'. The Outlook is negative. Fitch has also downgraded the company's senior unsecured rating to 'BB-' from 'BB+'. Bonds issued by Zoomlion H.K. SPV Co. Ltd have also been downgraded to 'BB-' from 'BB+'.

The downgrade reflects Zoomlion's weaker than expected business performance during the industry downturn and its rapidly deteriorating financial profile. We maintain the negative Outlook as there is no visibility of industry recovery and sustained improvement in Zoomlion's working capital position which remains uncertain. However, Fitch believes its financial profile can recover to levels supporting its current rating when the industry recovers from its current trough. Zoomlion's ratings are supported by its industry leadership position and continuous efforts on product diversification.

The one-notch difference between the company's Long-Term IDR and its senior unsecured rating reflects a high level of onshore debt that has priority claim over its offshore debt. Of Zoomlion's total debt of CNY33.2bn, onshore debt accounts for CNY26.9bn.

KEY RATING DRIVERS
Revenue still falling: Zoomlion's revenue fell by 33% YoY to CNY25.9bn in 2014, which has continued to drive down its EBITDA margin to 8.5% from 12.6% in 2013 since its selling, general and administrative expenses (SG&A) were relatively fixed. The company's revenue fell by 46% in total from the peak and its EBITDA margin was more than halved. We have yet to see this trend come to an end in 1Q15 as the company's revenue fell by another 29.5% YoY.

Surging debt level: The company's total debt has increased to CNY25.9bn in 2015 from CNY12.8bn in 2014, mainly driven by the CNY9.8bn increase in net working capital. A significant increase in working capital is the predominant reason. Despite the falling revenue, the company's accounts receivables and inventory rose by 15% and 19%, respectively, due to slower collection processes and reconciliation of some off-balance sheet exposure. On the other hand, its accounts payable fell by 25% in 2014. Capex, acquisition and reduced funds from operations accounted for the balance of the debt increase.

Deteriorating financial profile: Its funds from operations (FFO) interest coverage ratio fell from 3.39x in 2013 to 1.26x in 2014. Meanwhile, its FFO adjusted net leverage rose sharply from 1.76x in 2013 to 11.49x in 2014. This distressed situation may persist in 2015 as end-demand continues to bottom. In the medium term, we believe the ratio will improve as FFO normalises to a higher level.

Macro environment remains weak: The macro environment is not going to lend much help as China's fixed assets investment intensity is decreasing. Although the government is trying to decelerate the process by providing various policy support, the trend is not going to revert any time soon. That means the tough operating environment for Zoomlion will persist over the coming years. Given the over-capacity situation, we believe the market will remain competitive and pricing power will stay weak.

Diversification Benefits Take Time: Zoomlion acquired 67.51% of Chery Heavy Industry Co., Ltd. (renamed as Zoomlion Heavy Machinery Company Limited) for CNY2.349bn to expand its footprint into the argri-machinery segment. Meanwhile, Zoomlion also made progress on environmental related business through acquisition. The strategy will diversify the company's product offering and provide more business stability, given the low correlation among these segments. However, it will take time for the new segments to become meaningful revenue and profit contributors.

Maintaining market leadership: Zoomlion remains the market leader in its core operating segments in terms of both market share and technological advantage. The company ranked No. 1/No. 2 in its core segments including concrete machinery, crane and sanitation machinery. It has also demonstrated its dedication to technology leadership through its R&D and acquisition activities. We believe Zoomlion still has a strong business profile that will sustain it through the industry trough. As the industry consolidates and demand starts to stabilise, Zoomlion will exit this business cycle with a financial profile that is supportive of its current ratings.

KEY ASSUMPTIONS
Fitch's key assumptions within the rating case for Zoomlion include:
- Revenue to decline by 7.6% in 2015 and grow by 10% each in 2016 and 2017
- Working capital to stay flat in 2015 and decline significantly in 2016 and 2017
- Capex (including acquisition) to decrease to less than CNY1bn from 2015-2017

RATING SENSITIVITIES
Negative: Future developments that may, individually or collectively, lead to negative rating action include:
- further sustained declines in sales;
- lack of improvement in receivable days and inventory days;
- EBITDA margin below 8% on a sustained basis;
- FFO-adjusted net leverage sustained above 3x;
- failure to maintain its current market share in key business segments.

Positive: If the factors mentioned in the negative sensitivities do not materialise in the next 12 to 18 months