OREANDA-NEWS. China Hongqiao Group Limited's (Hongqiao, BB/Stable) high leverage at the end of 2015 was mostly driven by increased capex that has resulted in larger scale and improved cost competitiveness, which have strengthened its business profile, says Fitch Ratings. However, the company's ability to deleverage in 2016 may be hampered, should capex remain elevated or aluminium prices weaken, which may put pressure on the company's ratings.

Hongqiao's FFO-adjusted net leverage increased to almost 4.0x at the end of 2015, which compared with 3.2x at end-2014 and the 3.0x level above which Fitch would consider taking negative rating action. The increase was mainly caused by significantly higher capex spending of CNY17bn (2014: CNY9.4bn) to increase aluminium production capacity and add captive power plants in China, as well as to expand its alumina production facility in Indonesia.

The expansion of its aluminium capacity to close to 5.2 million tonnes per annum (Mtpa) at the end of 2015 makes Hongqiao the largest aluminium producer in the world. The investments to expand alumina and power plant capacities have helped the company to remain cost competitive because they have resulted in a high level of self-sufficiency for the key production inputs of alumina and electricity. Its EBITDA margin only fell to 30% in 2015 from 34% in 2014, compared with the more than 13% fall in aluminium prices during the same time.

We expect Hongqiao's capex to remain high at around CNY15bn-16bn in 2016 as the company continues to invest in additional capacities for aluminium production (to 6.0Mtpa) and captive power plants. We also expect Hongqiao to deleverage in 2016 to bring FFO-adjusted net leverage towards 2.5x, given higher FFO due to larger scale and recovering aluminium prices.

However, Hongqiao's ability to deleverage could be hampered if it does not exert discipline on capex or aluminium prices weaken beyond our expectations. A 5% drop from our current aluminium price assumption of USD1,700 per tonne would result in FFO-adjusted net leverage reaching over 3.0x in 2016-2017, from our current expectation of around 2.5x. An increase in capex of CNY5bn would also result in an increase in FFO-adjusted net leverage to over 3.0x in 2016-2017.