OREANDA-NEWS. Fitch Ratings has upgraded China-based monosodium glutamate (MSG) and xanthan gum producer Fufeng Group Limited's (Fufeng) Long-Term Issuer Default Rating (IDR) and senior unsecured rating to 'BB' from 'BB-'. The Outlook is Stable.

The upgrade reflects improving performance in the MSG business driven by industry consolidation, as well as stronger cash flow generation and declining leverage. Fitch expects Fufeng to turn free cash flow positive from 2015 as its capex requirement falls.

KEY RATING DRIVERS

Stronger Pricing Power: The China MSG market has consolidated over the past few years, as government policy forced capacity shutdowns and small, inefficient producers were squeezed out by weak pricing. The top two players now control more than 70% of capacity in China, which has translated into improved pricing power and margins. Fufeng is the biggest manufacturer globally by production capacity, and enjoys cost advantages, stemming from economies of scale, integrated facilities and proximity to raw materials, that are difficult to replicate.

Improving Performance in MSG: Fufeng's MSG business bottomed out in 2013. Gross margin improved to 15.7% and gross profit rose to CNY1,086/tonne in 1H15, from a low of 9.8% and CNY607/tonne in 1H13. Fitch believes that Fufeng will be able to sustain its current MSG margins amid weak pricing due to its cost advantages. Smaller players remain unprofitable at current MSG prices.

Xanthan Gum Remains Weak: Profitability in the xanthan gum segment has weakened in the past one to two years due to oversupply and weak demand from the oil and gas industry. Gross margin for xanthan gum dropped to 43% in 1H15 from 58% in 2013. Fitch expects the market to continue to be weak, and for xanthan gum to account for less than 30% of gross profit (2014: 33%).

Lower Capex Drives Deleveraging: The company expects its capex requirements to drop significantly from 2015 as there are no plans to expand MSG and xanthan gum capacity. Fitch expects FCF to turn positive in 2015 after several years of negative FCF. Fitch expects Fugeng's FFO-adjusted net leverage to drop to 1.6x by the end of 2015, which is low compared with that of other companies rated in the 'BB' category.

KEY ASSUMPTIONS

Fitch's key assumptions within our rating case for the issuer include:

- Gross margin of 15.8%-16.4% in the MSG segment in 2015-2018
- Gross margin of 42% in the xanthan gum segment in 2015, gradually declining to 35% by 2017
- Capex of CNY1.0bn in 2015 and CNY600m from 2016

RATING SENSITIVITIES

Positive: Future developments that may, individually or collectively, lead to positive rating action include:
- FFO-adjusted net leverage below 1.0x on a sustained basis
- Evidence Fufeng can sustain pricing power over several years

Negative: Future developments that may, individually or collectively, lead to negative rating action include:
- FFO-adjusted net leverage above 2.0x on a sustained basis
- Sustained negative free cash flow
- MSG gross profit per tonne falls below CNY1,000
- Sustained loss of market share.