S&P: Wanhua Chemical Group Co. Ltd. Outlook Revised To Positive On Rising Scale And Falling Leverage; 'BBB-' Rating Affirmed

S&P Global Ratings today revised its rating outlook on Wanhua Chemical Group Co. Ltd. (Wanhua) to positive from stable. At the same time, we affirmed the 'BBB-' long-term issuer credit on the company.

The outlook revision mainly reflects our view that Wanhua will continue to expand its operating scale and business diversity. This is supported by the successful ramp up of its new petrochemical facilities, and further investments in China and the U. S. We also expect the parent company's business restructuring plan--if approved by the relevant authorities--could boost Wanhua's scale and geographic diversity. In our base case, we assume continued strong profitability and operating cash flow. This will keep Wanhua's debt-to-EBITDA ratio below 2x over the next two years, despite rising capital expenditures.

Wanhua's petrochemical division should continue to contribute revenue and EBITDA over the next one to two years, following a successful production ramp-up in 2017 after a project delay in 2016. Liquid petroleum gas (LPG) is benefitting from relatively stable market conditions. We anticipate this business line will maintain a high utilization rate, and may also generate group synergies. In particular, we foresee a certain degree of integration with Wanhua's downstream polyurethane product lines.

Wanhua's parent, Wanhua Industrial Group Co. Ltd. (Wanhua Industrial), plans to consolidate the group's methylene diphenyl diisocyanate (MDI) under Wanhua. This is a positive for the rated entity because the group has a global leading position in the niche MDI market. Meanwhile, Wanhua is expanding its downstream polyurethane business, with more specialized applications. In our view, this will also boost the company's performance over the next two years. Wanhua is also building an MDI facility in the U. S. This expansion is another factor that we believe will improve Wanhua's geographic exposure and bring higher stability to its performance. However, the U. S. contribution will not start until 2021.

We expect Wanhua to continue to benefit from the favorable market conditions and enjoy a good product spread, particularly in its MDI and downstream polyurethane related businesses. Prices for both pure and polymeric MDI in China have remained elevated since the second half of 2016, given several supply issues as well as relatively strong demand. That said, we forecast moderately declining product prices over 2018-2019, due to global capacity additions.

Our base case assumes lower sales in 2018, reflecting lower MDI product price after a very strong year in 2017. But the company's expansion into downstream polyurethane and petrochemicals is likely to offset the lower MDI price and support mid-single-digit sales growth for Wanhua over 2019-2020.

We expect sustainable profitability--with a strong EBITDA margin at 25%-30%--to help the company generate positive free operating cash flow over the next one to two years. However, Wanhua's more aggressive capital spending plan is likely to prevent any material debt reduction. In our base case, we assume capital expenditure (capex) will increase to Chinese renminbi (RMB) 8 billion to RMB9 billion annually in 2018-2019, from RMB 6 billion in 2017. The higher capex will finance projects to enhance Wanhua's geographic exposure, expand business diversity, and boost capacity in more specialized downstream product lines.

By our estimates, Wanhua's ratio of debt to EBITDA will stay between 1.3x - 1.7x over the next two years, from a very strong 1.0x at the end of 2017.

We believe a planned business restructuring of Wanhua's parent, Wanhua Industrial Group Co. Ltd. (Wanhua Industrial), could further strengthen Wanhua's business risk profile. Wanhua accounted for about 80% of Wanhua Industrial's revenue and EBITDA in 2017, while the remaining was mostly contributed by the group's Hungary-based subsidiary, BorsodChem (BC). The plan would include injecting BC into Wanhua. BC's business performance has improved notably through the integration with the Wanhua Industrial group in technology and management. Accordingly, we believe that Wanhua's planned merger with BC could further improve Wanhua's business scale and geographic diversification. However, the details are still uncertain and subject to approvals from the relevant authorities.

We affirmed the rating due to uncertainty about Wanhua's capital structure and business profile after the planned group restructuring. In particular, we are not certain whether the company will maintain disciplined capital expenditures and cash dividends payment to sustain a strong debt leverage, despite likely further strengthening in its business profile and its currently low debt leverage.

The ratings continue to reflect Wanhua's strong leadership position in the global niche MDI market, adequate operating efficiency, and strong profitability. The strengths are currently offset by Wanhua's narrow business scope and geographic exposure, compared with leading global chemical peers, volatile historical performance, and inherent risk of price competition from the company's other non-MDI chemical products due to oversupply in the region.

We have raised Wanhua's group credit profile (GCP) to 'bbb-' from 'bb+' due to the group's improving business scale and diversity. This is supported by Wanhua's production ramp-up at its new petrochemical facilities and BC's improving performance following successful integration.

We continue to view Wanhua as a core and the insulated subsidiary of Wanhua Industrial. As such, Wanhua can be rated one notch higher than the GCP. Currently, the GCP of 'bbb-' is the same as Wanhua's stand-alone credit profile.

The positive outlook reflects our view that Wanhua will continue to grow its operating scale and business diversity over the next 24 months, while at the same time maintain its strong leadership position and technology capability in the global niche MDI market. The outlook also reflects our view that the restructuring of its parent, Wanhua Industrial, will have a positive impact on Wanhua's business scale and diversity. This is despite some uncertainty, including whether all aspects of the plan will be approved. Meanwhile, we believe Wanhua can maintain its strong profitability and therefore keep its debt to EBITDA ratio below 2x over the next two years, even after accounting for higher capital expenditures to support future growth.

We may raise the rating on Wanhua, if the company continues to expand its operating scale and business diversity, including through a merger with BC after the group restructuring, while sustaining its ratio of debt to EBITDA below 2x over the business cycle.

We may revise the outlook back to stable if:Wanhua's profitability declines substantially and its ratio of debt to EBITDA weakens materially. This could stem from larger-than-expected oil and chemical prices moves hitting margins in the core MDI business over the next two to three years; or a setback in the development of the lower-margin commodity petrochemical business in China.. We also believe the GCP of Wanhua's parent is highly likely to be affected in such a scenario. We lower Wanhua Industrial's GCP. This may stem from any setback on the restructuring, sharply weakened performance of Wanhua or its foreign subsidiary in Hungary, or any large acquisition materially hurting its financial risk profile.
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