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Rating Action:

Moody's assigns B2 CFR and senior unsecured rating to ZhengTong; outlook stable

 The document has been translated in other languages

06 Jan 2020

Hong Kong, January 06, 2020 -- Moody's Investors Service has assigned a B2 corporate family rating (CFR) to China ZhengTong Auto Services Holdings Ltd. (ZhengTong).

At the same time, Moody's has assigned a B2 senior unsecured rating to the proposed USD notes to be issued by ZhengTong.

The outlook is stable.

The bond rating reflects Moody's expectation that ZhengTong will complete the bond issuance upon satisfactory terms and conditions, including proper registrations with the National Development and Reform Commission in China (A1 stable).

ZhengTong will use the bonds' proceeds to refinance its existing debt and for general corporate purposes.

RATINGS RATIONALE

"ZhengTong's B2 rating is supported by the company's diversified brand portfolio and leading position in China's fast-growing luxury car dealership market," says Roy Zhang, a Moody's Assistant Vice President and Analyst.

ZhengTong recorded a total revenue of RMB37.5 billion in 2018 with 112,574 units of new car sales, making it one of the largest auto dealers in China. Over the years, the company has expanded its network to encompass 141 stores in 41 cities across 17 provinces and municipalities in China by the end of June 2019. Its large operating scale, supported by deep geographical diversification, helps to improve its efficiency and business resilience.

With a strong brand portfolio mainly focused on the luxury car market, ZhengTong benefits from a structurally growing luxury car segment characterized by low penetration, rising disposal income and increasing consumption. In addition, the company is able to generate higher margins than its peers in other car segments and reduce operating volatility associated with concentration in a single brand, given its diversified brand portfolio.

ZhengTong's after-sales services generated gross profits of RMB2.0 billion in 2018, accounting for roughly 45% of total gross profits. This segment generates recurring revenue with high margins, helping it mitigate industry downturns and improve business stability.

ZhengTong's financial services subsidiary, Shanghai Dongzheng Automotive Finance Co., Ltd (SDAFC), which is regulated by The People's Bank of China (PBOC), has separately listed on the Hong Kong Stock Exchange in April 2019. ZhengTong remains SDAFC's largest shareholder with a 71% stake at the end of June 2019. The listing has improved SDAFC's financial transparency and flexibility, as well as its financial independence from ZhengTong. Moody's has analyzed ZhengTong on a consolidated basis with SDAFC, given its high ownership, tight operational links and shared reputational risks.

However, the rating is constrained by ZhengTong's high funding needs and weak liquidity. Its leverage, as measured by total adjusted debt to EBITDA, increased to 6.5x at end June 2019 from 5.9x at the end of 2018, largely due to the expansion of auto finance business, a temporarily weak operating environment and increasing funding needs. The leverage is based on a consolidation of SDAFC's auto finance loan book as well, which represented 35.4% of ZhengTong's total consolidated loans and borrowings at end of June 2019. The increased consolidated leverage reflects the capital-intensive nature of auto finance business.

Moody's expects ZhengTong's debt to EBITDA ratio to stay around 6.5x over the next 12-18 months, as the company continues to expand its operating scale and increase borrowing through SDAFC.

Given its weak liquidity, ZhengTong has had to rely heavily on short-term financing, but it has typically been able to rollover this short-term debt. As of the end of June 2019, the company has reported unrestricted cash of RMB4.5 billion and restricted cash of RMB2.1 billion, with RMB18.7 billion of reported debt due in the next 12 months.

Moody's expects that the company will be able to continue to rollover its debt, given its profitable operations, strong market position and inventory of branded cars. The company has also demonstrated a track record of accessing diversified funding channels, including bank loans, commercial paper, syndicated loans, auto OEM financing and funding through the inter-bank market. In addition, its strategic relationships with auto makers and highly liquid working capital provide strong buffers against its liquidity needs. Moreover, it can access public equity funding via ZhengTong and SDAFC's listings in Hong Kong if needed.

ZhengTong's senior unsecured bond rating for the proposed USD notes is unaffected by subordination claims at the operating company level, because such claims are not material, based on Moody's expectation that the majority of the claims will remain at the holding company level.

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

The company benefits from the social trend of increasing car ownership in China, especially in the luxury segment. This trend is supported by China's improving infrastructure, rising disposable income and urbanization rate.

The company faces regulatory risks related to vehicle ownership controls, vehicle fuel economy and emission standards, as well as risks stemming from its financial services and used-vehicle sales. Any further tightening of related regulations could hamper sales.

As for governance, the company has been a listed and regulated entity since 2010. However, it has concentrated ownership with a key shareholder owning 56.4% as of 30 June 2019. In addition, its independent directors are in the minority in its board composition.

In terms of financial policy, the company relies on debt funded growth, which is partially mitigated by its improving non-debt funding channel through SDAFC listing.

The stable ratings outlook takes into account Moody's expectation that ZhengTong will maintain its leading market position, stable level of debt leverage and can refinance its short-term debt.

Upward ratings pressure could emerge if ZhengTong (1) maintains its business profile and access to diversified long-term funding sources, (2) strengthens its liquidity profile, (3) improves its debt leverage, and (4) grows the revenue and gross profit contribution of its auto maintenance business.

Specifically, credit metrics indicative of upward ratings pressure include adjusted debt/EBITDA trending towards 5.5x, and interest coverage, as measured by EBITDA/interest, exceeding 3.0x, both on a sustained basis.

On the other hand, downward ratings pressure could emerge if ZhengTong's (1) business profile weakens, (2) revenue and/or margins decline due to deteriorating market conditions or the termination of contracts with vehicle suppliers, (3) liquidity position or funding access weakens, or (4) interest coverage — as measured by EBITDA/interest — falls below 2.0x or leverage rises above 7.0x, on a sustained basis.

The last rating action was on 4 August 2017 when ZhengTong's B1 corporate family rating with a stable outlook was withdrawn due to business reasons.

The principal methodology used in these ratings was Retail Industry published in May 2018. Please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.

Incorporated in 1999, China ZhengTong Auto Services Holdings Ltd. (ZhengTong) is one of the leading players in the luxury car dealership market in China. Headquartered in Beijing, its operation encompassed 141 dealerships across 17 provinces by end June 2019. The company mainly focuses on luxury and ultra-luxury brands. ZhengTong's shares listed on the Hong Kong Stock Exchange in December 2010. Mr. Wang and his family owned 56.4% of the company at end June 2019.

REGULATORY DISCLOSURES

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.

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.

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
Asst Vice President - 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

Clement Cheuk Yiu Wong
Associate Managing Director
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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