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Rating Action:

Moody's assigns first-time B3 rating to Tongyi; outlook stable

 The document has been translated in other languages

18 Apr 2018

Hong Kong, April 18, 2018 -- Moody's Investors Service has assigned a first-time B3 corporate family rating (CFR) to Tongyi Industrial Group Co., Ltd. (Tongyi).

Moody's has also assigned a B3 senior unsecured rating to the proposed USD bond to be issued by Tongyi (BVI) Limited and guaranteed by Tongyi and Tongyi Group (HK) Limited. Tongyi Group (HK) Limited is a subsidiary of Tongyi and directly wholly owns Tongyi (BVI) Limited.

The ratings outlook is stable.

The bond rating reflects Moody's expectation that Tongyi will complete the bond issuance on satisfactory terms and conditions, including proper registration with the State Administration of Foreign Exchange in China (A1 stable).

The proceeds from the notes will be used to refinance existing debt and for general corporate purposes.

RATINGS RATIONALE

"Tongyi's B3 CFR considers its stable earnings, steady access to raw materials, as well as its low-cost operations that support its business profile and profitability," says Stephanie Lau, a Moody's Vice President and Senior Analyst.

Tongyi's steady access to raw materials is backed by the long-term relationships with its suppliers, including China's large national oil companies and international enterprises, such as China National Petroleum Corporation (CNPC; A1 stable), Mitsui, Showa Denko and Hanwha Total Petrochemical Co., Ltd. (Baa1 stable).

The company also enjoys cost benefits from its joint venture with CNPC - Fushun PetroChina Kunlun Gas Co., Ltd - which provides it with stable and continued carbon 4 (C4) supply, a key feedstock for the production of liquefied petroleum gas (LPG), methyl tertiary butyl ether (MTBE) and propylene.

In addition, Tongyi's three production plants are located in strategic locations that ensure transport cost efficiencies. For instance, its petrochemical plant in Fushun has guaranteed pipeline transport of raw materials between itself and a Fushun petrochemical plant of CNPC -- a key LPG supply location -- thus offering shorter transport distances than its competitors.

These strengths underpin Tongyi's good EBITDA margins, projected at around 7.5%-8.0% in the next 12-18 months, levels comparable to our rated commodity chemical peers. These margins would also be largely stable compared to the 8.0% registered in 2017, as the company's improved operational efficiency following production upgrades was partly offset by higher raw material prices.

Moody's expects Tongyi's adjusted EBITDA will grow by about 10% to RMB1.1-1.2 billion in the next 12-18 months from around RMB1.0 billion in 2017, underpinned by mild average selling price (ASP) growth for its commodity chemical products, and improved operational efficiency. Accordingly, Moody's expects Tongyi's will register adjusted EBITDA/interest coverage of 3.0x-3.5x in the next 12-18 months.

Tongyi's rating is constrained by its modest scale and production capacity relative to other B-rated commodity chemical peers. Its relatively small scale is reflected by its annual revenue size of RMB13.5 billion in 2017.

The rating is also constrained by its high product, geographical and customer concentration, leaving it vulnerable to potential regional economic downturns or unfavorable local market trends . The company's chemical manufacturing is focused on LPG, MTBE and propylene, with LPG and MTBE accounting for about 47% and 37% of overall chemical manufacturing revenue in 2017.

Tongyi's exposure to commodity chemical trading also raises business volatility, and in particular pricing, and counterparty risks. Tongyi's chemical trading business accounted for around 63% of its revenue but only about 48% of its gross profit in 2017.

Pricing risks are related to spot commodity price volatility, arising from Tongyi's trading in chemical products, including LPG, ethylene glycol, C4 and aromatics. There is also a degree of product concentration, with around 40% and 27% of Tongyi's trading revenue derived from LPG and ethylene glycol products in 2017.

Counterparty risks are highlighted by its customer concentration among private enterprises in northeast China. In 2017, the top five customers in its trading business contributed around 36% of its trading revenue, and around 23% of its consolidated revenue.

These risks are partially mitigated by the fact that Tongyi collects deposits from its customers ahead of transactions. In addition, its vertical integration -- through its ownership of a chemical manufacturing business -- mitigates the price volatility inherent to its trading business. Tongyi's trading business also helps to improve its bargaining power in the material procurement process with suppliers, which in turn enhances its cost benefits and profitability.

Moody's expects the company will record limited debt growth in 2018, as it has reduced its capex spending to around RMB430-450 million per annum, compared to over RMB1 billion in the last 12-18 months for production upgrades.

Accordingly, Moody's expects Tongyi's debt leverage -- as measured by adjusted debt/EBITDA (adjusted debt includes notes payables which the latter is net off by pledged cash) -- will peak at 4.5x in 2018 and subsequently fall to 3.0x-3.5x in 2019. This level of leverage is low for its B3 rating, but is counterbalanced by its small scale, high industry cyclicality and limited financial flexibility.

The ratings also consider Tongyi's weak liquidity profile and limited financial flexibility. As of the end of 2017, the company's RMB829 million of unrestricted cash and expected RMB500-550 million operating cash flow were insufficient to cover its debt obligations maturing over the next 12 months, including RMB1.5 billion in short-term borrowings and RMB1.0 billion private onshore bonds puttable in 2018.

Given its private-owned status and high pledged-assets ratio, its ability to refinance debt will largely depend on the successful issuance of its proposed offshore bonds. A failure to complete the issuance as planned could pressure the ratings.

These risks are somewhat mitigated by the company's track record of successful short-term debt refinancing and its good access to the domestic bond market.

The senior unsecured rating is not notched down from the B3 corporate family rating, reflecting Moody's expectation that the majority of claims will be at the holding company level.

The ratings outlook is stable, reflecting Moody's expectation that Tongyi will successfully refinances its short-term obligations and sustain its earnings and margins in the next 12-18 months, while remaining prudent in its expansion plans.

Upward ratings pressure could emerge over time if Tongyi: (1) improves its liquidity and financial flexibility, such that its unrestricted cash coverage to short-term debt remains above 1.0x; (2) expands its scale while sustaining its profit margins, and improves its business profile with better customer and geographical diversification; (3) adheres to a prudent financial policy.

On the other hand, Tongyi's ratings could be downgraded if: (1) it fails to refinance its short-term obligations or its liquidity weakens further due to a weakened operational performance or elevated use of short-term debt to fund its operations; (2) its revenue or EBITDA declines due to company-specific issues or a weakening in its operating environment; (3) its credit metrics materially deteriorate, such that adjusted debt/EBITDA exceeds 5.5x or EBITDA/interest expense falls below 2.0x; (4) it fails to sustain prudent financial management and engages in aggressive expansion.

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

Established in 1997, Tongyi Industrial Group Co., Ltd. is a private chemical company that engages in production and trading of commodity petroleum chemicals. The company is based in Fushun, Liaoning, China. Tongyi's major manufactured products include liquefied petroleum gas (LPG), methyl tertiary butyl ether (MTBE) and propylene, and its trading products include LPG, ethylene glycol and C4.

The company generated RMB13.5 billion in revenue in 2017 and had a total asset size of around RMB10 billion at year-end 2017.

As of 31 December 2017, Mr. Song Tieming, chairman of the company, owned around 34% of the company and his wife, Ms. Li Yuan, owned 66%.

REGULATORY DISCLOSURES

For ratings issued on a program, series or category/class of debt, this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series or category/class of debt 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.

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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.

Stephanie Lau
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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