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Rating Action:

Moody's revises outlook on ZhengTong to negative

 The document has been translated in other languages

27 Mar 2020

Hong Kong, March 27, 2020 -- Moody's Investors Service has affirmed China ZhengTong Auto Services Holdings Ltd.'s B2 corporate family rating and the B2 senior unsecured debt ratings on the notes issued by ZhengTong.

At the same time, Moody's has changed the outlook on the company's ratings to negative from stable.

RATINGS RATIONALE

"The negative outlook reflects our view that ZhengTong's operating performance in 2020 will likely be weaker than we had previously expected due to the coronavirus outbreaks, stretching its metrics and raising refinancing risk," says Roy Zhang, a Moody's Assistant Vice President and Analyst.

The rapid and widening spread of the coronavirus outbreak, deteriorating global economic outlook, falling oil prices, and asset price declines are creating a severe and extensive credit shock across many sectors, regions and markets. The combined credit effects of these developments are unprecedented. More specifically, ZhengTong's exposure to retail and discretionary consumption have left it vulnerable to shifts in market sentiment, especially given its sensitivity to consumer demand.

"That said, the impact is partially mitigated by ZhengTong's leading market position in the less competitive luxury and ultra-luxury segments, its resilient business model, and its strong banking relationships," adds Zhang.

While new vehicle sales have started to recover as auto retailers resume operation, Moody's expects slower economic growth and weaker consumer confidence will affect auto demand in China. In the first two months of 2020, the coronavirus outbreak and closure or retail stores resulted in a 42% drop in China auto sales according to the China Association of Automobile Manufacturers. This steep decline follows an 8.2% drop in auto sales in 2019.

Moody's expects ZhengTong's revenue will decline by 5.2% in 2020 due to lower business volumes. The company has 20 stores in Hubei province, which has been heavily affected by the coronavirus. These stores accounted for 14.2% of its total stores in China at the end of June 2019.

The impact is partially mitigated by ZhengTong's leading market position. Moody's expects ZhengTong will benefit from industry consolidation and be able to capture a good share of sales once demand recovers in the second half of 2020 and over 2021. ZhengTong also benefits from its focus on the luxury and ultra-luxury segments, where penetration is still low in China and demand is more resilient.

ZhengTong's after-sales services also generate recurring revenue with high margins, mitigating the impact from industry downturns and improving business stability. This segment generated gross profits of RMB2.0 billion in 2018, accounting for roughly 45% of total gross profit.

As a result, Moody's expects ZhengTong's leverage, measured by total debt to EBITDA, to increase to 7.1x at the end of 2020, up from 6.5x at end June 2019.

Moody's B2 corporate family rating continues to reflect the company's strong position in China's fast-growing luxury car dealership market, its large network, strong geographic coverage, the diversity of its brand offering and the high contribution of after-sales business. However, the rating is constrained by its high funding needs and weak liquidity.

ZhengTong's liquidity is weak. ZhengTong generally relies heavily on short-term financing, but has so far been able to rollover this short-term debt. At the end of June 2019, the company had 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 rolling over its debt, given its profitable operations, strong market position and inventory of branded cars. The company also has a track record of accessing diversified funding channels, including bank loans, commercial paper, syndicated loans, auto OEM financing and funding through the interbank market.

ZhengTong's issuance of a USD173 million bond in the first quarter of 2020 has also improved its maturity profile.

In addition, its strategic relationships with automakers and highly liquid working capital provide strong buffers against its liquidity needs. Moreover, it can access public equity funding via ZhengTong and its subsidiary, Shanghai Dongzheng Automotive Finance Co., Ltd's (SDAFC), listings in Hong Kong if needed.

The senior unsecured bond rating on the proposed USD notes is unaffected by subordination to 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.

Moody's regards the coronavirus outbreak as a social risk under its ESG framework, given the substantial implications for public health and safety. Today's action reflects the impact on ZhengTong of the breadth and severity of the shock, and the broad deterioration in credit quality it has triggered.

In terms of governance risk, the company's ownership is concentrated in its key shareholder, who held a 56.4% stake as of 30 June 2019. In addition, only a minority of its board comprises of independent directors. These concerns are partly mitigated by the company's listed status.

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's listing.

Moody's could change the outlook to stable if ZhengTong (1) maintains its business profile and access to diversified long-term funding sources, (2) strengthens its liquidity profile, and (3) sustains its debt leverage below 7x.

Moody's could downgrade the rating 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 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. 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 at the end of 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 the end of 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.

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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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