OREANDA-NEWS. Fitch Ratings has downgraded China-based Hilong Holding Limited's (Hilong) Long-Term Issuer Default Rating (IDR) and senior unsecured ratings to 'BB-' from 'BB'. The Outlook is Negative.

The downgrade reflects Hilong's weaker profitability, which will result in a slower-than-expected deleveraging. The Outlook remains Negative as oil companies continue to trim capex, which will negatively impact the funds flow from operations (FFO) of suppliers like Hilong.

KEY RATING DRIVERS

Slower-than-Expected Deleveraging: Hilong's FFO is not likely to be sufficient to support continued deleveraging in 2015 and 2016, because EBITDA is not likely to recover given lower global oil drilling activity. Hilong's FFO-adjusted net leverage increased to 3.2x in 2014 from 1.5x in 2013, and we expect it to increase to 3.7x in 2015, driven by an around 20% decline in FFO in 2015.

Lower Profitability in 2015: The company's EBITDA margin declined to 23% in 1H15 from 25% in 1H14, with EBITDA down 1% year-on-year. Revenue for Hilong's core drill pipe manufacturing business declined 52% in 1H15 as a result of the lower oil drilling activities. We expect the weakness to persist. Despite the weakness, Hilong's market position remained unchanged: 16% share by output in drill pipes and 17% in oil country tubular goods (OCTG) coating in the international market, and 45% share in drill pipes and 75% in OCTG coating in the domestic market.

FCF to Improve: Hilong was able to manage its working capital efficiently, and even though it posted weaker EBITDA, it reported higher CFO of CNY166m in 1H15 compared with CNY252m in 2014 and negative CFO of CNY84m in 1H14. We expect the company's FCF to improve in 2015 thanks to the shorter cash conversion cycle and lower capex. The cash conversion cycle was 280 days in 1H15 (355 days in 1H14 and 324 days in 2014), with a decrease in inventory days and increase in payables days. Capex was CNY195m in 1H15, and we expect capex to be around CNY300m annually for 2015 and 2016, coming off from 2014's CNY1.2bn.

KEY ASSUMPTIONS

Fitch's key assumptions within our rating case for the issuer include:
- No significant change to the company's market share
- Capex will be no more than CNY800m in total from 2015 to 2017
- EBITDA margin maintained at 23% for 2015 to 2017

RATING SENSITIVITIES

Negative: future developments that may, individually or collectively, lead to negative rating actions include:
- EBITDA margin declines to below 20% on a sustained basis
- Significant deterioration in market share
- FFO net leverage increases to above 4x on a sustained basis

Positive: future developments that may, individually or collectively, lead to positive rating actions include:
- Evidence showing a continuous deleveraging trend