OREANDA-NEWS. Fitch Ratings has affirmed China Oriental Group Company Limited's (COG) Long-Term Foreign-Currency Issuer Default Rating (IDR) and senior unsecured rating at 'BB-'. The Outlook is Stable. Fitch has also affirmed COG's USD300m 7% notes due 2017 at 'BB-'.

The affirmation reflects the steel producer's strong financial flexibility and ability to generate free cash flow and reduce leverage through effective working capital management, even when profit margins are thin due to excess domestic production capacity and intense pressure on selling prices.

KEY RATING DRIVERS

Strong Financial Flexibility: COG successfully reduced its net debt position to CNY1.1bn in 2015 from CNY7.3bn in 2014 through effective working capital management. This was largely done through conversion of the company's large pool of notes receivable to cash and extending repayment of notes payable. The company used the bulk of the proceeds for the repurchase and principle repayment of its outstanding US dollar notes due in 2015 and 2017. Fitch expects COG's FFO-adjusted net leverage to remain below 2.0x in 2015 and 2016, after the company liquidated the bulk of its working capital.

Core Products Support Margins: COG's margins for its H-section steel products were resilient despite pressure on selling prices arising from industry-wide production overcapacity. This was due to its market leadership for this product segment. COG's H-section steel products remained profitable in 2015 and were one of the major contributors to gross profit and EBITDA for the company. H-section products and strip steel products generated gross profit per ton of CNY64 and CNY50 respectively in 2015, which offset losses from the billets and cold-rolled sheets business.

Weak Industry Fundamentals Persist: Fitch expects the domestic steel industry to remain fundamentally weak in the near term. However, further sharp declines in steel prices are less likely following a slight demand recovery and rebound in average selling prices due to a likely increase in construction activities in 2016, which will benefit COG's long products. In addition, total Chinese steel production capacity is expected to peak in 2016 with capacity elimination outpacing additions from 2016 onwards.

Repurchase of USD Notes Completed: COG completed the buyback of some of its USD300m 7% notes due 2017 in February 2016, leaving USD79m of bonds still outstanding. The repurchase was largely financed by unrestricted cash on hand, conversion of notes receivable and use of available credit facilities. In addition to the repurchase, COG also successfully removed all restrictive covenants that limit COG's ability to incur additional debt. Fitch believes that this could be credit negative for COG should the company seek to issue more debt in domestic markets where interest rates have been more attractive and invest in its steel operations. Fitch will monitor COG's financial profile closely and take appropriate rating action should leverage increase.

Continued Support from ArcelorMittal: The company's ratings are also supported by ArcelorMittal S.A. (BB+/Negative). Fitch expects ArcelorMittal to remain committed to the Chinese steel market, with China Oriental as one of its key integrated steel manufacturing investments in China.

KEY ASSUMPTIONS

Fitch's key assumptions within our rating case for the issuer include:
- Single digit revenue growth in 2016-2018
- Capex of CNY400m in 2015, CNY700m in 2016 and CNY700m in 2017.
- EBITDA margin to remain around 5%-7% between 2016 and 2018.

RATING SENSITIVITIES

Negative: Future developments that may, individually or collectively, lead to negative rating action include:
- FFO-adjusted net leverage sustained above 3.0x
- Sustained negative free cash flow

Positive: Future developments that may, individually or collectively, lead to positive rating action include:
- FFO-adjusted net leverage below 1.5x on a sustained basis
- Gross profit per ton of steel products exceeding CNY80 on a sustained basis