OREANDA-NEWS. Fitch Ratings has downgraded China XD Plastics Co Ltd's (XD Plastics) Long-Term Issuer Default Rating (IDR) to 'B+' from 'BB-'. The Outlook is Stable. Fitch has also downgraded the senior unsecured rating of the company and the rating on the outstanding senior unsecured US dollar notes issued by Favor Sea Limited, a wholly owned company by XD Plastics, to 'B' from 'B+', with a Recovery Rating of 'RR5'.

The downgrade reflects the company's inability to defend its margin as demand slows. Fitch believes the company's credit profile is more consistent with the 'B' rating category, due to its lack of diversification. However, its strong market position and comfortable leverage and coverage ratios support its 'B+' rating.

KEY RATING DRIVERS

Pricing Power Deteriorates: XD Plastics has failed to defend its margin as demand from auto manufacturers slows down and competition intensifies. EBITDA margin fell to 10% in 3Q15 from 18% in 2014 while revenue fell by 24% yoy in 3Q15 to USD239m. The sharp fall in EBITDA margin reflects XD Plastics' weak negotiation power against its customers.

XD Plastics' competitors are adding production capacity aggressively while domestic auto demand is decelerating. Fitch expects domestic auto sales to recover slightly in 2016, but this is likely to be offset by the strong supply coming online, which will continue to put pressure on margins.

Near-Term Deleveraging Unlikely: New projects in Sichuan (300 kilo tonnes) and Dubai (16.2 kilo tonnes) would continue to stretch XD Plastics' balance sheet. The company has total payments of USD298m due within a year on property, plant and equipment, and Fitch expects the company will require an additional USD200m of working capital for the operation of the new facilities. Therefore, the deleveraging process is unlikely to happen before 2017.

Bumpy Overseas Development: XD Plastics has halted supplies to a new, direct customer in South Korea that accounted for 12.6% of total revenue in 2014 because of payment collection issues. The incident was one of the key reasons for its weak 3Q15 performance. Without this customer, the top five distributors would account for about 70% XD Plastics' total revenue, raising concentration risk. The management has been actively resolving the dispute and believe they could resume business with the same customer by January 2016 at the latest. In addition, the company is committed to develop its overseas presence through its investment in a Dubai project.

Comfortable Liquidity and Leverage: Fitch expects the company's FFO-adjusted net leverage ratio to peak at 3.5x in 2016 when the Sichuan project comes online, a level that supports its new rating. XD Plastics had USD243m in cash on hand and USD234m in unused credit facilities at end September 2015. This, and operating cash flow, should be sufficient to cover the USD266m of short-term debt (including long-term debt due within one year) and required capex of USD300m.

Sichuan Project Key to Deleveraging: Fitch believes XD Plastics' Sichuan project, which will increase capacity by 77%, is strategically important to the company. Completion of the plant will not only enhance XD Plastics' market leadership in China, but also diversify its operation base, which is now at Harbin. The new plant's location is much closer to end-clients, which would greatly reduce transportation costs and improve XD Plastics' competitive position in the expanding market in south-west China.

If the Sichuan project can reach full capacity in 2017 and achieve financial performance comparable to the company's existing plant, the strong cash flow could help XD Plastic to deleverage. However, should risks commonly associated with new chemical facilities - including project delays, unstable initial operation and capacity absorption - materialise, XD Plastics' credit profile would be negatively affected.

KEY ASSUMPTIONS

Fitch's key assumptions within our rating case for the issuer include:
- Revenue to decrease 15% in 2015, and increase 10% in 2016, 50% in 2017 and 20% in 2018
- EBITDA margin to recover to 15%-16% in 2015-2018
- Capex of USD250m and USD200m in 2015 and 2016, respectively

RATING SENSITIVITIES

Negative: Future developments that may, individually or collectively, lead to negative rating action include:
-FFO-adjusted net leverage sustained above 3.5x
-EBITDA margin sustained below 12%
-Significant cost overruns and/or delays in expansion projects

Fitch does not envisage any positive action until XD Plastics demonstrates margin stability.