S&P downgrades West China Cement outlook

S&P downgrades West China Cement outlook
Published: 10 January 2012

Standard & Poor's Ratings Services said today that it had revised its outlook on the long-term corporate credit rating on West China Cement Ltd. (WCC) to negative from stable. At the same time, we affirmed the 'BB-' long-term corporate credit rating, and the 'BB-' issue rating on the company's outstanding senior unsecured notes. We also lowered our Greater China scale rating on the company and its notes to 'cnBB' from 'cnBB+'.

"We revised the outlook on WCC because we expect the company's profitability to deteriorate," said Standard & Poor's credit analyst Lawrence Lu. "We also expect WCC's working capital requirements to increase and its capital expenditure to remain high as it aggressively adds capacity.

“Lower demand and intense price competition will continue to eat into WCC's profit margin in 2012, in our view. Delays in railway and highway construction projects in China's Shaanxi province have resulted in weaker demand for higher-grade cement. WCC has therefore shifted focus to lower-grade lower-margin products used in the rural construction market to maintain its satisfactory capacity utilization. Heavy rains in Shaanxi province, which accounts for more than 97% of the company's adjusted production capacity, also resulted in lower demand for cement.

“We believe WCC's competitiveness is weakening as larger and more geographically diversified competitors enter Shaanxi. Competitors include Anhui Conch Cement Co (not rated) and Tangshan Jidong Cement Co (not rated). These new entrants are financially stronger than WCC and have resorted to aggressive pricing (in some cases at below cost) to garner market share. Prolonged price competition could further depress WCC's profitability.

“We expect WCC to continue to generate sizable negative free operating cash flow in 2012, increasing its reliance on debt. We also anticipate that the company's working capital requirements may continue to increase given that the domestic credit market remains tight and the demand for cement is weakening. In addition, WCC incurred substantial capital expenditure to expand its capacity (including acquisitions) in 2011. The company's capital expenditure will remain fairly high in 2012 as well. WCC targets increasing its production capacity to 25-30Mt by 2015, from 16.2Mt as of June 30, 2011.

“The negative outlook reflects our expectation that the operating environment for WCC will stay challenging in 2012 and that the company's profit margin will remain pressured.

"We may lower the rating if WCC's financial leverage increases to more than 4x and remains there.

This could happen if cement prices and demand are weaker than we expected with no signs of improvement," said Mr. Lu. We could also lower the rating if the company's expansion is more aggressive than we anticipated and is largely debt funded.

“We may revise the outlook to stable if the operating environment in Shaanxi stabilizes such that WCC maintains an EBTIDA margin of more than 30% and a debt-to-EBITDA ratio of less than 3x. A stable environment should translate into greater visibility on price and demand.”