Fitch Ratings has affirmed Chinese chemical company Shanghai Huayi (Group) Company's (Huayi) Long-Term Issuer Default Rating (IDR) and senior unsecured rating at 'BBB-'.

The Outlook on the IDR is Stable.

Huayi is wholly owned by the Shanghai State-owned Assets Supervision and Administration Commission (Shanghai SASAC). The ratings are assessed on four factors under Fitch's Government-Related Entities (GRE) Rating Criteria, resulting in a two-notch uplift from the Standalone Credit Profile (SCP) of 'bb'.

The Stable Outlook reflects our expectation that government support will remain strong and Huayi's operations will remain stable, with net leverage remaining above 2.5x over 2022-2025.

Key Rating Drivers

'Strong' State Control and Support: Fitch assesses Huayi's status, ownership and control by the Shanghai government as 'Strong' because the company is strategically important to the city as the sole chemical corporation owned by Shanghai SASAC. Huayi remains 100%-owned by Shanghai SASAC. It undertakes scientific research projects in advanced materials for sectors including national defence, large aircraft and alternative energy.

Shanghai SASAC has provided support to Huayi consistently in the form of direct subsidies and capital injections, especially for R&D in specific chemical projects. Fitch expects the support to continue and therefore, we have assessed the support record and expectation factor at 'Strong'.

'Moderate' Impact on Funding: Fitch assesses the financial implications of a Huayi default as 'Moderate' because Huayi is an active domestic bond issuer, but the company's size is moderate compared with other Shanghai state-owned enterprises (SOEs). A Huayi default would only have a moderate impact on the funding market access of other Shanghai SOEs. However, Fitch assesses the social and political impact of a Huayi default as 'Weak', as the company operates in a highly competitive market with a large number of rivals and replacement products.

Strong Linkage with Subsidiary: Fitch fully consolidates Huayi's 41.99%-owned A-share listed associate, Shanghai Huayi Group Corporation Limited (Shanghai Huayi), in its analysis, given the absence of legal ringfencing and Huayi's absolute control over the listco under our Parent and Subsidiary Linkage Rating Criteria. This is evident from Huayi and its subsidiaries having significant deposits placed with, and borrowings from, Shanghai Huayi's financial company, which acts as Huayi's centralised treasury. Huayi and its subsidiaries as well as Shanghai Huayi also provide raw materials to each other.

Stable Leverage, Increasing Scale: Fitch expects Huayi's net leverage (net debt/EBITDA) to increase to 2.6x in 2022 (2021: 1.9x). This is driven by high capex, revenue impact from the Covid-19-related lockdown in Shanghai and partially offset by higher average selling prices of chemical products, which we expect to come down in the next few years in line with our oil and gas price assumptions.

We expect capex to remain high at around CNY7 billion-10 billion over 2022-2023 as Huayi proceeds with Phase II of the Guangxi project, focusing on new material and fine chemical products. New project launches mean that we expect the company to benefit from rising scale and margin stability because of addition of high-value added products.

Derivation Summary

Fitch uses a bottom-up approach to rate Huayi under our GRE criteria, which is based on the SCP of 'bb' plus a two-notch uplift to 'BBB-', reflecting the potential support from the ultimate parent, Shanghai SASAC. The two-notch uplift is similar to that between other GREs and their government parents, such as Shanghai Construction Group Co., Ltd. (BBB+/Stable).

Huayi has exhibited higher cash flow volatility than other investment-grade chemical issuers because of its large exposure to the commodity chemical sector. Its 'bb' SCP is in line with Methanex Corp. (BB/Positive), which is the largest global supplier of methanol. Methanex has a strong business profile due to its geographical diversification and low cost base, and its leverage has also been lower than Huayi in recent years. Huayi's SCP is one notch lower than the 'BB+' rating of global chemical peers, such as Tata Chemicals Limited (BB+/Stable), which is more geographically diversified and shows less profit and leverage volatility.

Key Assumptions

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

Revenue to increase by 16.3% in 2022 followed by minimal growth over 2023-2024 and a 5.7% drop in 2025;

Operating EBITDA margin of about 15% in 2022, gradually decreasing to 12% in 2025;

Annual capex of CNY10 billion in 2022 followed by CNY6 billion-7 billion a year in 2023-2025;

No acquisitions over 2022-2025.

RATING SENSITIVITIES

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

Increasing likelihood of support from the Shanghai government;

Funds flow from operations (FFO) net leverage below 3.0x on a sustained basis;

Net debt/EBITDA below 2.5x on a sustained basis.

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

Weakening of linkage with the Shanghai SASAC;

FFO net leverage above 4.0x on a sustained basis;

Net debt/EBITDA above 3.5x on a sustained basis.

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

Adequate Liquidity: Huayi had CNY13.6 billion available cash as of end-2021, against CNY14.1 billion short-term debt. In addition, it also had unused banking facilities of over CNY80 billion. However, these facilities are uncommitted because committed facilities are uncommon in the Chinese banking industry.

Issuer Profile

Huayi is a medium-sized, state-owned chemical company with highly diversified products. It is the largest methanol producer in East China and among the three largest producers of acetic acid products in China. Over 90% of its total revenue is from China, with the rest from Thailand.

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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