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Rating Action:

Moody's assigns A3 to Hualu Holdings' senior unsecured notes

 The document has been translated in other languages

18 Oct 2021

Hong Kong, October 18, 2021 -- Moody's Investors Service has assigned a rating of A3 to the proposed senior unsecured notes to be issued by Hualu International Finance (BVI) Limited and guaranteed by Hualu Holdings Co., Ltd. (Hualu, A3 stable).

Hualu will use the proceeds from the issuance to finance onshore project construction, offshore businesses, and for refinancing.

The outlook on the rating is stable.

RATINGS RATIONALE

"The A3 rating of the proposed notes reflects the unconditional and irrevocable guarantee from Hualu, and the fact that the notes rank pari passu with Hualu's other senior unsecured obligations," says Roy Zhang, a Moody's Vice President and Senior Analyst.

The proposed issuance will have limited impact on Hualu's leverage. The company's adjusted debt/EBITDA will remain around 1.2x for 2021 and 2.3x for 2022 after factoring in this new debt. This leverage level positions the company well at its current Baseline Credit Assessment (BCA).

Hualu's A3 issuer rating combines its baa3 BCA and a three-notch uplift reflecting Moody's assessment of Hualu's high likelihood of support from, and high level of dependence on, the Shandong government, and ultimately, the Government of China (A1 stable) in times of need.

The support assessment reflects Hualu's 100% ownership by, and very close linkage with, the Shandong government; its strategic importance to the Shandong government as the province's only window liaison company in Hong Kong SAR, China (Hong Kong, Aa3 stable) to foster political and economic ties between Shandong and Hong Kong, and an important carrier of the province's industrial upgrade policy; and track record of support received from the Shandong government.

Moody's expects the central government to likely support efforts by the Shandong government to prevent Hualu from defaulting and, thereby, avoid the risk of disruption to the domestic financial markets. This support can take various forms, including government subsidies, capital or asset injections, and loans from policy and state-owned commercial banks.

Moody's assessment of a high level of dependence reflects the fact that Hualu and the central government are exposed to common political and economic event risks.

Hualu's baa3 BCA reflects its long operating track record and established domestic market positions in its core coal-chemical and pharmaceutical businesses, moderately diversified business portfolio, solid financial metrics, and strong access to funding.

However, the BCA is constrained by Hualu's exposure to volatility in commodity prices and industry overcapacity, evolving regulatory policies; and increased capital spending, which will raise leverage.

Hualu is a state-owned capital investment company controlled by the Shandong government. Originally a window liaison company in Hong Kong for the Shandong government, Hualu continues to serve an important role in coordinating the political, economic, and personnel exchanges between Shandong-based companies and various institutes with the political and business communities in Hong Kong.

The majority of Hualu's EBITDA comes from its coal-chemical and pharmaceutical segments, via its three listed subsidiaries, Shandong Hualu Hengsheng Chemical Co., Ltd.(HLHS), Shandong Xinhua Pharmaceutical Company Ltd (XHP) and Shandong Lukang Pharmaceutical Co., Ltd. (LKP). HLHS, XHP and LKP, in aggregate, accounted for over 95% of Hualu's total consolidated revenue and adjusted EBITDA, and over 85% of Hualu's reported assets in 2020 and the first six months of 2021.

HLHS, XHP and LKP are leaders in their respective niche markets, with established business positions underpinned by technical expertise, integrated production lines, sales networks and cost leadership. The strong business positions help the three companies build a competitive edge in the market, and navigate through industry cyclicality.

The coal-chemical industry is highly cyclical and oversupplied, while the pharmaceutical industry is competitive and highly regulated. While the industry dynamics affect Hualu's businesses in different ways, these unrelated sectors provide moderate business diversification and reduce the volatility in Hualu's overall revenue and gross profit.

Hualu has solid financial metrics. The company's adjusted debt/EBITDA was low at 1.3x-1.7x in 2018 to 2020 and 1.0x for the last 12 months (LTM) in the first half (H1) of 2021, while its funds from operations (FFO)/debt were above 50% in 2018 to 2020 and peaked at 87% for LTM H1 2021. These ratios were driven by strong EBITDA and FFO in both up and down cycles, which could cover the majority of the companies' annual maintenance capital spending and working capital, with small incremental debts to cover the balance.

Moody's expects Hualu's debt/EBITDA to rise to around 2.3x in 2022 from 1.2x in 2021, and its FFO/debt to decline to around 35%-40% in 2022 from 73% in 2021. This is because Hualu, via HLHS, will build a second coal-chemical production base in Jingzhou Hubei in the coming one to two years. This additional capital expenditure, coupled with the potential softening of coal-chemical prices and demand in 2022, will raise leverage. That said, the higher leverage level that Moody's estimates still positions Hualu well at the BCA of baa3.

Hualu also maintains a solid financial profile at the holding company level despite its less than majority ownership in its three key listed subsidiaries. The annual dividend of around RMB150 million to RMB300 million Hualu receives is more than sufficient to cover its operating and interest expenses, with a strong FFO/interest coverage of around 10x-35x in 2018 to 2020, and in H1 2021.

Hualu's liquidity on a consolidated basis is inadequate. As of the end of June 2021, Hualu's RMB3.4 billion cash balance and estimated RMB5.7 billion of operating cash flow are insufficient to cover its RMB3.3 billion short-term maturing debt, projected dividend payment and around RMB6.4 billion of capital expenditure over the next 12 months.

But this is mitigated by Hualu's strong access to funding. Hualu has established long-term relationships with over 25 state commercial and policy banks. As of the end of June 2021, on a consolidated basis, Hualu had available bank facilities of around RMB46 billion, with around RMB39 billion, or 85%, unutilized. In addition, Hualu and its three listed subsidiaries have ready access to equity and bond markets.

The rating also takes into account the following environmental, social and governance (ESG) factors.

The chemical sector faces high environmental risks. Producers of chemicals face litigation risk and incur remediation costs for soil and water pollution if accidents, leaks or chemical exposures to humans occur during the process of manufacturing, storage and distribution, or if new research identifies an adverse environmental impact from an established product. HLHS also needs to meet tightening environmental standards as the Chinese government increasingly focuses on environmental protection. As an industry leader, Hualu, via its subsidiary HLHS, continues to invest in equipment and processes to manage environmental risks and remains compliant with environmental regulations.

The chemical and pharmaceutical sectors have high social risks. Hualu, via its subsidiaries HLHS, XHP and LKP, uphold a high standard in providing a safe and healthy working environment for employees, and producing reliable and high-quality products for end-users.

Regarding governance factors, the rating takes into consideration Hualu's status as a state-owned entity that is ultimately controlled, supervised and monitored by Shandong State-Owned Assets Supervision and Administration Commission (SASAC). Also, Hualu is transparent in disclosing its investment strategy, financial policy and plans, with over 95% of its consolidated revenue and adjusted EBITDA derived from its three key listed subsidiaries.

FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATING

The stable outlook reflects Moody's expectation that there will be no significant change in Hualu's credit profile or its strategic importance to the Shandong and Chinese governments over the next 12-18 months.

Moody's will upgrade the notes rating if Hualu's issuer rating is upgraded, which could be driven by the company's BCA improvement.

Hualu's BCA could be raised if Hualu's major operations improve sustainably in terms of business stability and market position. Credit metrics indicative of an improvement in its BCA include debt/EBITDA lower than 1.5x on a sustained basis.

Moody's could downgrade the notes rating if Hualu's issuer rating is downgraded, which could be driven by a weakening in the company's BCA or in the rating agency's support assessment from the government.

Hualu's BCA could be lowered if the business and financial profiles of Hualu's major operations weaken. Credit metrics indicative of a lowering of the BCA include Moody's adjusted debt/EBITDA rising above 3.0x for a prolonged period.

A downgrade of Hualu's issuer rating without a lowering of its BCA could also be triggered by a weakened support assessment due to the reduction in the company's importance to the Shandong government and, ultimately, the Chinese government.

The methodologies used in this rating were Chemical Industry published in March 2019 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1152388, and Government-Related Issuers Methodology published in February 2020 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1186207. Alternatively, please see the Rating Methodologies page on www.moodys.com for a copy of these methodologies.

Hualu Holdings Co., Ltd. (Hualu) is a state-owned capital investment company 59.16% owned by Shandong SASAC, 16.90% by Shandong Guohui Investment Co., Ltd. (Baa2 stable), 12.17% by Shandong Finance Investment Group Co., Ltd (A2 stable), 8.45% by Shandong Social Security Fund, and 3.32% by Shandong Development and Investment Holding Group Co Ltd as of 30 June 2021. Shandong SASAC is the actual controller of the company.

The company is Shandong government's window liaison company in Hong Kong SAR, China, and operates in three commercial segments, namely coal-chemical, pharmaceuticals, and environmental protection. The company is also engaged in leasing and trading businesses.

Hualu reported revenue of RMB24 billion in 2020 and RMB18 billion in the first half of 2021.

The local market analyst for this rating is Sue Su, +86 (106) 319-6505.

REGULATORY DISCLOSURES

For further specification of Moody's key rating assumptions and sensitivity analysis, see the sections Methodology Assumptions and Sensitivity to Assumptions in the disclosure form. Moody's Rating Symbols and Definitions can be found at: https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_79004.

For ratings issued on a program, series, category/class of debt or security this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series, category/class of debt, security or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

The rating has been disclosed to the rated entity or its designated agent(s) and issued with no amendment resulting from that disclosure.

This rating is solicited. Please refer to Moody's Policy for Designating and Assigning Unsolicited Credit Ratings available on its website www.moodys.com.

Moody's considers a rated entity or its agent(s) to be participating when it maintains an overall relationship with Moody's. Unless noted in the Regulatory Disclosures as a Non-Participating Entity, the rated entity is participating and the rated entity or its agent(s) generally provides Moody's with information for the purposes of its ratings process. Please refer to www.moodys.com for the Regulatory Disclosures for each credit rating action under the ratings tab on the issuer/entity page and for details of Moody's Policy for Designating Non-Participating Rated Entities.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Moody's general principles for assessing environmental, social and governance (ESG) risks in our credit analysis can be found at http://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1288435.

The Global Scale Credit Rating on this Credit Rating Announcement was issued by one of Moody's affiliates outside the EU and is endorsed by Moody's Deutschland GmbH, An der Welle 5, Frankfurt am Main 60322, Germany, in accordance with Art.4 paragraph 3 of the Regulation (EC) No 1060/2009 on Credit Rating Agencies. Further information on the EU endorsement status and on the Moody's office that issued the credit rating is available on www.moodys.com.

The Global Scale Credit Rating on this Credit Rating Announcement was issued by one of Moody's affiliates outside the UK and is endorsed by Moody's Investors Service Limited, One Canada Square, Canary Wharf, London E14 5FA under the law applicable to credit rating agencies in the UK. Further information on the UK endorsement status and on the Moody's office that issued the credit rating is available on www.moodys.com.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

The first name below is the lead rating analyst for this Credit Rating and the last name below is the person primarily responsible for approving this Credit Rating.

Roy Zhang
Vice President - Senior Analyst
Corporate Finance Group
Moody's Investors Service Hong Kong Ltd.
24/F One Pacific Place
88 Queensway
Hong Kong
China (Hong Kong S.A.R.)
JOURNALISTS: 852 3758 1350
Client Service: 852 3551 3077

Gary Lau
MD - Corporate Finance
Corporate Finance Group
JOURNALISTS: 852 3758 1350
Client Service: 852 3551 3077

Releasing Office:
Moody's Investors Service Hong Kong Ltd.
24/F One Pacific Place
88 Queensway
Hong Kong
China (Hong Kong S.A.R.)
JOURNALISTS: 852 3758 1350
Client Service: 852 3551 3077

No Related Data.
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