Fitch Ratings has affirmed Chinese chemical company Shanghai Huayi Holdings Group Co., Ltd.'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 (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 at around 3.0x over 2023-2025.

Key Rating Drivers

'Strong' State Control and Support: We assess 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. 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. We expect the support to continue, which results in our assessment of the support record 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 default by Huayi would have only moderate impact on the funding market access of other Shanghai SOEs. 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 our analysis, given the absence of legal ring-fencing and Huayi's absolute control over the listed company under our Parent and Subsidiary Linkage Rating Criteria. Shanghai Huayi's financial company acts as Huayi's centralised treasury. Huayi and its subsidiaries as well as Shanghai Huayi provide raw materials to each other.

New Projects Improve Diversification: We expect Huayi's expansion into fine chemicals such as propylene derivatives and bisphenol A (BPA) to improve its diversification. Huayi completed phase II of its Guangxi Project by end-2022, adding capacity for 0.75 million tonnes per year of propylene and 0.2 million tonnes per year of BPA and related derivatives, which we expect to generate CNY7 billion and CNY12 billion in revenue in 2023 and 2024, respectively. We also expect greater exposure to high-value-added fine chemicals to improve Huayi's margin stability.

Stable Margins: Fitch estimates Huayi's EBITDA margin narrowed to around 13% in 2022, from 16% in 2021, due to an expected 30%-40% reduction in the average selling price (ASP) of coal chemical products such as methanol and acetic acid, as demand fell in China amid pandemic-related restrictions.

We do not expect further material downside risks in the ASPs of Huayi's main products, despite our expectation of lower oil and natural gas prices in 2023 because demand in China will recover after its reopening. Therefore, we expect Huayi's EBITDA generation to remain at around CNY8 billion per year over 2023-2025.

Steady Leverage Profile: We estimate Huayi's net leverage (net debt/EBITDA) increased to 2.7x in 2022 from 1.9x in 2021 due to moderating EBITDA generation and continued capex for the Guangxi Project. We believe the company's net leverage will be sustained at around 3.0x despite expected capex of CNY5 billion-7 billion a year over 2023-2025 for the construction of Phase III of the Guangxi Project because the capex would mostly be covered by its operating cash flow.

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 companies because of its large exposure to the commodity chemical sector. Its 'bb' SCP is one notch lower than the ratings of Methanex Corp. (BB+/Stable) and Tata Chemicals Limited (BB+/Positive). Methanex, the largest global supplier of methanol, has a stronger market position, wider geographical diversification and stronger financial metrics than Huayi, despite a less-diversified product portfolio than Huayi. Tata Chemicals is smaller than Huayi, but is more geographically diversified, with less profit and leverage volatility.

Key Assumptions

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

Revenue increases by 5% in 2022, 12% in 2023, 7% in 2024 and 2% in 2025

Operating EBITDA margin of about 13% in 2022 and 11% over 2023-2025

Capex of CNY10 billion in 2022, CNY5 billion in 2023, CNY7 billion in 2024 and CNY7 billion in 2025

RATING SENSITIVITIES

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

Increasing likelihood of support from the Shanghai government

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 Shanghai SASAC

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 CNY18.8 billion in available cash as of end-September 2022, against CNY11.2 billion in short-term debt. It also had unused banking facilities of CNY100 billion. However, these facilities are uncommitted because committed facilities are uncommon in the Chinese banking industry.

Issuer Profile

Huayi is a medium-sized chemical SOE with diversified business segments, including coal chemicals (methanol, acetic acid), tyres for heavy-duty trucks, new chemicals (chlor-alkali, fluorochemical) and fine chemicals (acrylic acid, paints). Around 85% of its total revenue is generated in China. The overseas revenue comes from export of chemical products and tyre sales from its production base in 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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