OREANDA-NEWS. Fitch Ratings has published eHi Car Service Limited's (eHi) Long-Term Foreign-Currency Issuer Default Rating (IDR) of 'BB-' and senior unsecured rating of 'BB-'. The Outlook is Stable. Fitch has also assigned eHi's proposed US dollar senior unsecured notes an expected rating of 'BB-(EXP)'.

eHi's ratings are supported by the increasing economies of scale it enjoys in a fast-growing Chinese car rental and car service industry. It is the second-largest company by fleet size in the combined car rental and car service industry, and is extending this lead over smaller competitors given its stronger funding position through substantial equity funding. Having predictable contractual income from its B2B car service business further supports its ratings. eHi's ratings are, however, constrained by its small scale, large capex needs, and the industry's sensitivity to regulatory changes. The company also lacks a long track record of disposing of used cars without incurring significant losses.

eHi's Stable Outlook reflects its improved profitability during expansion, which will help to keep its leverage below 2.5x and FFO fixed charge coverage above 3x, despite rising debt levels.

The notes are rated at the same level as eHi's senior unsecured rating because they constitute direct, general, unsubordinated and unconditional obligations to eHi. The final ratings are contingent upon the receipt of final documents conforming to information already received.

KEY RATING DRIVERS

Adequate Funding for Fast Expansion: Fitch expects eHi to expand its fleet size to 39,000 vehicles at end-2015 from 19,746 at end-2014 after having raised USD304m in equity funding from an IPO in November 2014 and other sources. The near-doubling of its fleet in 2015 follows a 71% increase in 2014. This rapid increase in business scale drove revenue 50% higher to CNY851m in 2014 and revenue is likely to reach CNY1.5bn in 2015.

Improving Operating Leverage: eHi is set to benefit from wider margins following the significant increase in scale. The improvement in operational efficiency is mainly due to the combined effect of increasing fleet size per service location and decreasing staff numbers per vehicle. Fitch expects EBITDA margin (excluding gain/loss on car disposal) to increase from 33% to above 40% in 2015. This will help to drive EBITDA growth of over 40% in each of the next two years, and help to keep FFO net leverage below 2.5x (2014: 1.9x).

Predictable Contractual Service Income: eHi has a well-established reputation in B2B car services (including short term and long term) and also provides long-term self-drive car rentals, which together accounted for more than 30% of its net revenue in 2014. It has more than 32,000 corporate long-term clients, some of which are large multinational companies. Fitch believes eHi's B2B business will continue to generate CNY300m-600m in revenue in 2015-2016, which will provide a cushion to the company in case of distress.

Competitive Pressure: eHi has a smaller fleet size than industry leader, CAR Inc. (CAR, BB+/Stable), which had a fleet size of 69,000 as of March 2015. This puts pressure on eHi to expand to narrow the market share gap with CAR, which continues to expand aggressively. Competition for market share will put more pressure on eHi's financial profile than on its bigger competitor. eHi generated EBITDA of CNY270m versus CAR's CNY1,597m in 2014.

Unproven Car Disposal Track Record: eHi has not needed to dispose of a large number of vehicles because the fleet is still very young. eHi is currently relying on auction companies to dispose of its vehicles but it has explored other channels, including working with third-party online platforms and establishing a repurchase programme with auto manufacturers. eHi has yet to prove it is able to dispose of a large number of venhicles and create a sustainable fleet renewal cycle. Considering the immature used-car market in China, car disposal will be one of the main challenges facing eHi in the future.

Regulation Risk: The Chinese car rental and car service industry is mainly regulated by local government authorities without a national governing law. The regulations often vary by geography and are subject to changes and practical deviations. Any unexpected change in regulations could adversely impact eHi's operations. Although these risks are not imminent, the industry is at an early stage of development in China and there are likely to be regulatory changes before the industry matures and stabilises.

KEY ASSUMPTIONS
Fitch's key assumptions within our rating case for the issuer include:
-Total fleet size will almost double to 39,000 in 2015. 2015-2019 total fleet size will have a CAGR of 30%.
-Net revenue will increase more than 75% in 2015 and enjoy a CAGR of more than 30% in 2015-2019.
-Fleet depreciation schedule: 15% of gross fleet value.
-Existing vehicles purchased before June 2014 will be disposed in 3.5 years; new vehicles purchased after June 2014 will be disposed in 2.75 years.
-Capex/car rental vehicle is CNY100,000 and capex/car service vehicle is CNY225,000.
-EBITDA margin will increase to more than 45% in 2015 and reach 59% in 2019.

RATING SENSITIVITIES
Negative: Future developments that may, individually or collectively, lead to negative rating action include:
- FFO adjusted net leverage sustained above 3x;
- EBITDA margin (excluding gain/(loss) from car disposal) sustained below 45%;
- EBIT margin (excluding gain/(loss) from car disposal) sustained below 20% (2014: -2.1%);
- Significant loss from car disposals or evidence of difficulty in establishing a track record of selling used cars at reasonable terms; and
- Evidence of greater government, regulatory or legal intervention leading to an adverse change in the company's operation and business profile.

Positive: Future developments that may, individually or collectively, lead to positive rating action include;
- No positive rating pressure in the next 12-18 months until the company achieves significant increase in scale while keeping FFO adjusted net leverage below 2.5x during the growth stage.