OREANDA-NEWS. Fitch Ratings says China XD Plastics Co Ltd's (B+/Stable) leverage will rise in 2016 due to continued weakness in operating EBITDA margin and sustained high capex. However, we expect the maker of modified plastics to start deleveraging in 2017.

XD Plastics' 2015 year-end FFO-adjusted net leverage of 1.5x was better than we expected in early November 2015, when we downgraded the company's rating. The better-than-expected results were primarily driven by margin recovery in 4Q15 and significant extension of accounts payable days, which resulted in higher cash inflow for 2015.

The company's rating reflects Fitch's expectation that its leverage will rise in 2016 to around 2.5x-2.8x before falling in 2017 once its new Sichuan and Dubai plants become fully operational and increase output, which will result in significant sales growth.

We expect XD Plastics' operating EBITDA margin to remain at 15%-16% (2015: 16.3%) given our subdued outlook for the operating environment for the company. The company's single largest end-user, China FAW Group (FAW), which accounted for about 40% of XD Plastics' revenue in 2015, saw a 10% fall in vehicle output and 8% drop in auto sales volume. This compares with growth in production and sales at other major auto makers in China. Fitch expects auto sales in China to rise in the mid- to high-single digits in 2016, but FAW's growth could be lower due to its uncompetitive products and internal restructuring.

In addition, the majority of XD Plastics' capacity and revenue sources are in northeastern China, where output growth has slowed over the past few years. This was because auto makers have moved their capacities to central and western China to meet strong demand and take advantage of attractive local-government investment policies. As a result, XD Plastics plans to offset the slower growth in northeastern China by diversifying into other regions and building production capacity in growth regions.

XD Plastics' capex is likely to remain high in 2016 at USD160m-180m due for investments in its Sichuan and Dubai production sites and an R&D centre in China. The new plants will increase XD Plastics' capacity for automotive plastics by 50%-60% from its current capacity of current 395,000 tons.