OREANDA-NEWS. Fitch Ratings has assigned Weichai Power Co., Ltd.'s (Weichai; BBB/Stable) USD400m 4.125% senior unsecured notes due 2020 a final rating of 'BBB'.

The notes are issued by Weichai International Hong Kong Energy Group Co., Limited, and unconditionally and irrevocably guaranteed by Weichai. The proceeds of the proposed issue will be used to repay bank borrowings related to the group's offshore operations. The notes are rated at the same level as Weichai's senior unsecured debt rating as they represent direct, unconditional, unsecured and unsubordinated obligations of the company.

This final rating follows the receipt of documents conforming to information already received and is in line with the expected rating assigned on 15 September 2015.

KEY RATING DRIVERS
Leader in Key Markets: Weichai is the largest manufacturer of heavy duty truck (HDT) engines in China (36% market share by sales in 2014) and forklifts in Europe (35% market share by sales in 2014). These segments are the company's core profit pools. Weichai is also the largest supplier of HDT transmissions, axles and wheel loader engines in China based on sales volume. Weichai spends 3%-5% of its revenue on R&D each year. Its technology know-how, strong distribution network, service network and deep market understanding, create moderate to high barriers to entry.

Well-Balanced Business Portfolio: The 38.25% ownership of KION Group adds diversification benefits to Weichai's standalone credit profile. After consolidation, Weichai has a well-balanced business portfolio in terms of product mix, geographic exposure and end-market exposure. It derives roughly 50% of its revenue from the HDT value chain in China and 40% from the forklift value chain in Europe after fully consolidating the KION Group in 2015. These two markets have low correlation to each other. Weichai's engine and HDT products rely on infrastructure and property demand in China, while KION Group's forklift products are driven by manufacturing and logistics activities in Europe. The integration of KION Group has reduced overall business volatility.

Resilient Performance in Downturns: Weichai's EBITDA margin, which has historically averaged 13.8%, has been resilient in previous downturns, due to its low operating leverage and strong pricing power. Weichai's revenue declined by 13.8% and EBITDA margin was 11.3% in 2005, when Chinese HDT sales fell by 32%. In 2012, Weichai's revenue fell by 17.8% and EBITDA margin was 10.4%, as Chinese HDT sales declined by 29%.

Strong Financial Profile: Weichai's (excluding KION Group) average free cash flow margin of 5.4% in 2002-2014 was higher than the industry average, driven by its higher exposure to the engine and components segment. We view the company's financial policy as conservative. On top of its net cash position, it had CNY24.4bn in cash on hand at end-2014, and total credit facilities of CNY54.1bn, of which CNY50.3bn was unused. Weichai enjoys strong access to external financing channels, including onshore and offshore banks and capital markets, due to its state-owned enterprise status.

Competition to Intensify: We expect the Chinese HDT market to gradually come off the peak, which will reduce demand for Weichai's engines and other products. We expect Chinese HDT sales to hover around 500,000-700,000 units a year compared with 1.01m units in 2010. Overall industry utilisation would remain low while the five biggest HDT manufacturers with more than 80% combined market share are increasingly making their own engines. The combination of tougher competition and waning demand could result in lower market share and margin pressure for Weichai's HDT engine business in the near to medium term.

KEY ASSUMPTIONS
Fitch's key assumptions within the rating case for Weichai include:
- HDT truck sales and HDT engine sales to stabilise from 2016 with stable margin
- Forklift sales will grow at a mid-single-digit rate with stable margin
- Depreciation to stay below CNY5bn annually
- Dividend pay-out ratio to be around 10%

RATING SENSITIVITIES
Positive: Positive rating action is not expected in the medium term unless there is material change of business profile with improving scale, profitability and stability.

Negative: Future developments that may, individually or collectively, lead to negative rating action include:
- Engine and forklift businesses lose competitiveness on a sustained basis
- Revenue (deconsolidating KION Group) continues to fall beyond 2015
- Free cash flow turns negative on a sustained basis (deconsolidated)
- Failure to maintain net cash position on a sustained basis (deconsolidated)
- Failure to maintain control over KION Group
- KION Group's FFO adjusted gross leverage sustained above 2x