OREANDA-NEWS. July 06, 2015. Fitch Ratings has affirmed China-based Shanghai Electric Group Company Limited's (SE) Long-Term Foreign-Currency Issuer Default Rating (IDR) and its foreign-currency senior unsecured rating at 'A'. The Outlook is Stable. Fitch has also affirmed the 'A' rating of the EUR600m 1.125% senior unsecured notes due 2020 issued by its wholly owned subsidiary, Shanghai Electric Newage Company Limited. The notes are unconditionally and irrevocably guaranteed by SE.

The affirmation reflects SE's ability to maintain a strong order backlog amid weakening demand for thermal power equipment and intensifying market competition; its leading position in China's nuclear power equipment sector; and an overall large net cash position, which supports the standalone rating at 'A-'. The company continues to benefit from moderate-to strong-support from Shanghai Municipal Government, which results in an additional one-notch rating uplift.

KEY RATING DRIVERS

Thermal Sales Sluggish: Total revenue from coal-fire equipment was down 25% in 2014 while gross margins retreated by 2.5pp to 22.0% - from 24.5% in 2013. It was another tough year for the coal-fire power equipment segment as manufacturers battled amid sector overcapacity and shrinking demand. Fitch expects gross margins to continue to decline as competition intensifies further. However, cuts in average selling prices (ASP) will be partially mitigated by more stringent cost-control measures and SE's shift towards higher-margin products.

Stable Order Backlog: We expect SE's order backlog to remain stable due to its strong market position combined with the growing investment in renewable energy - which will partially mitigate falling demand for thermal power equipment. SE posted positive new-order growth in 2014 despite weak demand for coal-fire power equipment: CNY250.8bn in order backlog (excluding industrial equipment) represented 3.3x total revenue, or 4.9x ex-industrial equipment revenue, up from 3.0x and 4.4x, respectively in 2013.

Well-Positioned in Nuclear: Fitch believes SE will benefit from increased nuclear quota approvals due to its position as one of the leading nuclear island power equipment manufacturers in China - and the only domestic producer of Gen-3 nuclear island equipment. China is likely to reignite nuclear power development in 2015.

Nuclear island equipment sales fell short of previous expectations in 2014 due to limited new orders following the Fukushima incident in 2011. The company added CNY3bn of new orders for nuclear island equipment in 2014, bringing the total order backlog to CNY16bn. Management expects the current backlog to materialise as revenue within the next three to five years.

Maintaining Healthy Liquidity: SE enjoys ample corporate liquidity; with a large cash balance, steady FCF generation and access to bank financing and other external funding channels. The company had CNY25.1bn in unrestricted cash at end-2014 versus CNY7.8bn in debt. Fitch believes that SE's liquidity profile provides a strong buffer against potential counter-cyclical working-capital swings.

Linkages with Shanghai Municipal Government: Fitch believes SE is likely to receive support - either directly or indirectly, through parent Shanghai Electric (Group) Corporation (SEG) - from the Shanghai Municipal Government in the event of financial distress, given the company's leading market position in power generation equipment manufacturing, a pillar industry in China's economy. SE plays a strategic role in Shanghai's industrialisation, and is an important carrier for both the central government and the Shanghai Municipal Government to acquire leading electrical and mechanical technology through partnerships with global players and/or through overseas investments.

The company also frequently receives various types of government grants and subsidies from both national and local government bodies, and is actively engaged in government-sponsored strategic, scientific and high-tech research projects.

KEY ASSUMPTIONS

- EBITDA margin remain at approximately 9% between 2015-2018
- Capex to remain at around 2.5% of revenue
- No major M&A.

RATING SENSITIVITIES

Positive: Positive rating action is unlikely, unless there is significant improvement in SE's product and end-market diversification, including a substantial increase in its recurring service and after-sales revenue.

Negative: Factors that may, individually or collectively, lead to negative rating action include:
- SE experiences a sustained deterioration in its market position such as a consistent loss of market share in its core products, or a sustained weakening in its order backlog
- FFO margin is sustained below 6%
- SE's linkage with Shanghai Municipal Government is assessed to be weakening.