Fitch Ratings has affirmed aluminium manufacturer China Hongqiao Group Limited's (Hongqiao) Long-Term Foreign and Local Currency Issuer Default Ratings (IDR) at 'BB'. The Outlook is Positive. Fitch has also affirmed Hongqiao's senior unsecured rating at 'BB'.
The ratings are currently constrained by uncertainty over long-term alumina supply following the Indonesian bauxite export ban announced in May 2012. As a result, Fitch has not upgraded Hongqiao despite its 2011 performance exceeding the agency's expectations.
Hongqiao's main alumina supplier, Gaoxin Aluminium and Power, sources all of its bauxite from Indonesia. Due to regulatory uncertainty in Indonesia which resulted in the May 2012 ban, Hongqiao in Q411 started building in phases its own two million tonnes per annum (mtpa) alumina production capacity, which was completed in May 2012. This will supply 50% of its own alumina needs by 2013. The company has also been actively looking to source bauxite from other regions.
Honqiao achieved EBITDA per ton of CNY5,560 in FY11 despite an increasingly tough pricing environment in the Chinese aluminium sector. This is due to its cost advantage over other major Chinese aluminium producers, particularly in power and alumina supply, which account for roughly 75% of production costs.
Hongqiao has one of the few privately owned power grids in China, which lowers its power costs even in relation to other manufacturers with captive power plants. These cost advantages should improve as the company plans to reach 70% electricity self-sufficiency in 2013, up from less than 50% in 2011.
The ratings may be upgraded once the alumina supply issues have been resolved and there is certainty that Hongqiao will achieve 70% electricity self-sufficiency, while maintaining financial leverage, as measured by adjusted net debt/operating EBITDAR, below 1.0x. These developments will reinforce Hongqiao's cost advantages. After an upgrade, Fitch does not anticipate further positive actions as the ratings will be constrained by Hongqiao's concentration in Shandong province. Hongqiao has only three production sites, which are all located in Shandong Province, leaving it exposed to unexpected operational failure of any single factory and regulatory risk of the province.
The Outlook may be changed to Stable if Hongqiao fails to maintain low-cost alumina supply or improve its electricity self-sufficiency rate of 70% in 2013; or if EBITDA drops below CNY4,500 per ton on a sustained basis. Fitch may consider further negative rating action if there is deterioration in its business profile, resulting in EBITDA falling below CNY3,000 per ton on a sustained basis; or if net debt/ EBITDAR rises above 2.0x on a sustained basis.
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