Fitch Ratings has downgraded China-based auto dealer China Grand Automotive Services Group Co., Ltd.'s (CGA) Long-Term Foreign-Currency Issuer Default Rating (IDR) to 'CCC+' from 'B-' and senior unsecured rating to 'CCC+' from 'B-' with a Recovery Rating of 'RR4'.

A full list of rating actions is below.

The downgrade reflects Fitch's expectation of CGA's tightening liquidity and an inability to significantly deleverage. Fitch expects weak operating results in 4Q22 and further cash to at least partially repay upcoming long-term debt over the next one to two years will result in lower liquidity, which will decrease CGA's ability to service future debt repayments.

Fitch assumes a recovery in revenue and profitability in 2023 after operational disruptions from Covid-19 city lockdowns in 2022, but a muted growth outlook and execution risks could constrain cash flow generation and limit CGA's cash replenishment pace. Further weakening in liquidity and uncertainty over its ability to refinance upcoming capital-market debt maturities, particularly ahead of the US dollar January 2024 bond, could lead to negative rating action.

Key Rating Drivers

Deterioration in Liquidity Position: CGA has warned it will report a loss for 2022, the first time since its listing, after citywide Covid-19 lockdowns and the company provided higher discounts to boost new car sales in 4Q22. The actual cash erosion may not be as large as the net loss, although weaker operating cash flow than Fitch estimated should result in tighter liquidity. We currently expect that CGA will have sufficient cash on hand to repay the near-term onshore bond maturity in March. Even so, limited refinancing options will require a portion of liquidity to repay upcoming debt maturities.

CGA has a CNY950 million onshore bond due in March and a CNY1 billion bond becoming puttable by investors in the same month. It also has CNY1.15 billion in onshore corporate bonds maturing in 4Q23. CGA intends to repay bond maturity in March with cash on hand and short-term refinancing, but we believe the use of cash without material replenishment will further reduce its liquidity buffer. Tighter liquidity this year could cause greater uncertainty for refinancing CGA's concentrated maturities in 4Q23 and 1Q24, particularly its January 2024 USD232 million bond maturity.

Weaker Business Profile: CGA's warning of a loss for 2022 also implies weakness in operations and therefore operating cash generation. The impacts from citywide lockdowns in 2022 are likely to be reversed after China's reopening in December and CGA could expect a sharper rebound than peers because a higher proportion of its stores were located in affected areas last year.

Still, we expect dealers with high exposure to mass-market internal combustion engine vehicles (ICEV) are facing growing pressure from structural shifts from ICEVs to new energy vehicles (NEV) in 2023. Moreover, CGA's weaker sales volume than auto original equipment manufacturers' (OEM) quarterly or annual assessment may result in lower rebate receivables, which could further squeeze new car sales margins in the coming one to two quarters.

Strategy Risk: Fitch expects lower liquidity could inhibit CGA's ability to execute strategies to keep pace with industry shifts. Changes including higher exposure to premium and luxury brands will require higher prepayments and cash pledged against bank acceptance bills for the higher vehicle costs and catching up on industry electrification compared with better-capitalised peers in a competitive market.

Uncertainty in Industry Outlook: The removal of Covid-19 restrictions in China is positive for offline businesses like auto dealers. However, Fitch is forecasting a high single-digit decline in retail sales for traditional ICEVs in 2023 following the expiration of stimulus measures, challenges presented by electrification and weak consumer sentiment, particularly reducing demand for mass market and joint venture-branded vehicles. A lack of a significant recovery due to lacklustre ICEV sales and weak profit for NEV sales would limit CGA's cash generation and the ability to sustainably deleverage.

Reliant on Short-Term Financing: CGA has been increasingly reliant on short-term debt since 2020. The proportion of short-term debt in CGA's capital structure rose after excluding the current portion of long-term debt and loans from OEMs associated with inventory financing. The reliance may persist if it cannot secure additional long-term refinancing and such concentration increases the proportion of debt relative to available liquidity, which may limit its overall borrowing capacity. An improved debt maturity profile would be evidence of more diversified funding access and better financial flexibility.

Derivation Summary

CGA's ratings are driven by its tight liquidity and risks to the refinancing of its upcoming capital-market maturities.

Key Assumptions

Fitch's Key Assumptions Within Our Rating Case for the Issuer:

Revenue to decline by mid double digits in 2022 (2021: 0.1%) and recover from 2023;

CGA's EBITDA margin to recover slowly, averaging 4.5% in 2023-2025 (2021: 4.4%);

Capex (inclusive of M&A) to slow in 2022 and average CNY1.8 billion a year in 2023-2025 (2021: CNY2.7 billion);

No dividend payout in the medium term.

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to positive rating action/upgrade:

Material improvement in liquidity through higher operating cash flow and/or evidence of additional funding sources;

Improved visibility on ability to refinance upcoming capital-market debt maturities;

Evidence of free cash flow generation that can more sustainably support deleveraging.

Factors that could, individually or collectively, lead to negative rating action/downgrade:

Lack of progress in addressing upcoming capital-market debt maturities, such as refinancing the January 2024 US dollar bond;

Further deterioration in liquidity due to a lack of refinancing for upcoming maturing long-term debt and/or weakened operating cash flow.

Best/Worst Case Rating Scenario

International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.

Liquidity and Debt Structure

Tight liquidity: CGA had unrestricted cash of CNY9.8 billion at end-June 2022, against CNY40.7 billion in short-term borrowings. The short-term borrowings include perpetual securities that are callable every six months, in line with Fitch's criteria. However, CGA exercises the call option at its discretion, and Fitch does not assume the securities will be called in our liquidity analysis. The company redeemed part of the perpetual securities in July 2021, and USD261million remains outstanding.

CGA had unused bank credit facilities of CNY27.8 billion at end-September 2022, and it drew down a new long-term unsecured bank loan of CNY253 million in the fourth quarter of 2022.

Issuer Profile

CGA is one of the largest auto dealerships in China, with more than 780 outlets across China covering more than 50 brands as of end-December 2022. CGA is listed on the Shanghai Stock Exchange.

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

ESG Considerations

Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg

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