Various Rating Actions Taken On -Based Automakers On Challenging Industry Conditions And COVID-19 Uncertainty

• 03-Apr-2020 06:05 EDT

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OVERVIEW

• Slowing economic growth and weak prospects for demand will intensify competition in China's auto market, weighing on auto OEMs' financial performance and reducing their rating buffers.

• The global spread of COVID-19 adds uncertainty to the auto OEMs' operations, especially for companies with significant overseas operations or material exposure to global supply chains.

• We have taken various rating actions on six automakers that we rate in China.

HONG KONG (S&P Global Ratings) April 3, 2020--S&P Global Ratings today said it has taken various rating actions on six China-based automakers:

• We affirmed our 'A' ratings on Co. Ltd. and the outlook remains negative.

• We revised our outlook on China FAW Group Co. Ltd. to negative from stable and affirmed our 'A' rating on the company.

• We placed our 'BBB+' ratings on Beijing Automotive Group Co. Ltd. and core subsidiary BAIC Motor Corp. Ltd. on CreditWatch with negative implications.

• We placed our 'BBB-' ratings on Zhejiang Holding Group Co. Ltd. and core subsidiary Geely Automobile Holdings Ltd. on CreditWatch with negative implications.

Today's rating actions reflect challenging industry conditions, given that auto is one of the more affected sectors amid the global spread of COVID-19. The pandemic is exerting enormous pressure on economic growth and weakening consumer confidence and spending capabilities for large-ticket items. Additional expenses in relation to precautionary measures for safety production and operational difficulties from a potential global supply chain disruption add further to the burden for auto producers.

While rated original equipment manufacturers (OEMs) have resumed operations at all of their China plants, utilization has been low as demand is yet to recover meaningfully. We revised our assumptions for China auto sales in late March to an 8%-10% decline for 2020. Auto sales in the first quarter are likely to drop by 40%-45% year on year, but the decline has been narrowing week by week since March, with the coronavirus appearing to be largely under control in China. Our base case assumes auto sales to post a 6%-8% year-on-year decline in the second quarter, and then grow by 5%-6% in the second half of the year.

We believe the rated OEMs, all being industry leaders, will continue to outperform the industry. They have more attractive product offerings than their peers and have sufficient liquidity sources to weather the industry downturn. However, weakening demand will intensify market competition, lowering their margins and cash flows and reducing their rating buffers. The production suspension in Europe and the U.S., if prolonged, is likely to disrupt their operations, especially for companies with material overseas exposure either by production or supply chain.

We expect China's auto sales to see a potential recovery of 2%-4% in 2021, and hence improving margins and leverage ratios for the rated OEMs. However, we believe the risk is tilted toward the downside given the low visibility.

Environmental, Social, and Governance (ESG) credit factors for the credit rating changes:

• The COVID-19 outbreak (temporary production suspension and supply chain disruption).

• Dongfeng Motor Group Co. Ltd.

We affirmed the 'A' ratings on Dongfeng Motor Group Co. Ltd. (DFG) as production has resumed and is ramping up at both DFG and its parent, Dongfeng Motor Corp. (DFM).

We expect DFM's production to normalize and sales momentum to pick up from April, 2020, after its auto sales volume dropped by 37% year on year in the first two months. As pent up demand gradually releases, we expect the company's full year revenue under proportionate consolidation to decline by 10%-12% in 2020. Given the considerable volume loss in the first quarter and weak demand prospects, we now estimate the EBITDA margin of DFM on a proportionate consolidation basis to dip to 7%-8% in 2020. We expect auto demand to recover by 2%-4% in 2021 on the back of a potentially low base in 2020 and recovering economic growth. This should enable DFM to restore its sales volume to pre-epidemic outbreak levels and underpin an EBITDA margin of above 8%. However, the duration of COVID-19 brings uncertainty to the timing and magnitude of demand recovery and adds volatility to DFG's financial performance.

OUTLOOK

The negative outlook on DFG reflects our expectation that the operational disruption and weak Chinese auto market demand are weighing on the profitability of both DFM and DFG. As such, we expect the EBITDA margin of DFM under proportionate consolidation to fall below 8% in 2020. Any sustained recovery will be subject to the potential of market improvement, which is dependent on the duration of the COVID-19 outbreak and the government initiatives that could help revive the economy over the next 12-24 months.

We may lower the ratings on DFG if DFM's EBITDA margins, on a proportionate consolidation basis, decline to consistently below 8%, or if its debt-to-EBITDA ratios approach 1x.

This could happen if: (1) the company's sales volume is much weaker than we expect due to weak demand or prolonged production suspension because of COVID-19, (2) higher-than-expected pricing pressure due to intense industry competition, or (3) the losses of proprietary and PSA group (JV) brands materially increase due to failure in restructuring.

Although it is unlikely, we may lower the rating if we believe the likelihood of extraordinary support from the Chinese government is lower than our current assessment, or if we believe DFG is no longer a core subsidiary of the DFM group.

We may revise the outlook on DFG to stable if DFM's EBITDA margin, on a proportionate consolidation basis, recovers sustainably above 8%. This could happen if the production and sales volume of brands under DFM and DFG, especially for JVs with and , normalize to pre-epidemic levels without compromising profitability over the next 12-24 months.

• China FAW Group Co. Ltd. We revised our outlook on FAW Group to negative from stable and affirmed our 'A' rating on the company. We believe the company will face profitability strain over the next 12-24 months, given the weak prospects for auto demand amid slowing economic growth.

At the same time, we lowered our assessment on the company's stand-alone credit profile by one notch to 'bbb+'. In our view, the company's creditworthiness on a stand-alone basis stands less favorably than its peers in the 'a-' level, given its comparably weaker ability to safeguard its financial performance. We hence assigned a negative comparable rating analysis to reflect the above.

We anticipate FAW Group's revenue to decline by 4%-6% in 2020. FAW's sales volume dropped by 15% year on year in the first two months, in comparison to an overall industry decline of 42%. Our base case assumes a tick up in sales momentum and utilization from April, as pent up demand gradually releases on the back of supportive government policies.

In light of challenging industry conditions, FAW Group's adjusted EBITDA margin will likely fall toward 8% in 2020. This number excludes the margin of the sales company under the brand.

Meanwhile, FAW Group's operations are less exposed to a potential global supply chain disruption. This is because the company sources around 80%-90% of auto parts in China and currently maintains sufficient level of components inventory for near term.

We also expect the company to remain in a net cash position in 2020-2021, after deconsolidating captive finance operations.

OUTLOOK

The negative outlook on FAW Group reflects our expectation that the company's financial metrics will see downside risk, given weak auto demand prospects in China amid slowing economic growth. We currently estimate the adjusted EBITDA margin of the company to decline and approach our downgrade trigger of 8% in 2020, before a potential recovery to 9% in 2021.

We may lower the rating if FAW Group's EBITDA margins, excluding the sales company under the Toyota brand, drops persistently below 8%, or if its debt-to-EBITDA ratio approaches 1x. This could happen if: (1) the market is significantly weaker than we expect and FAW sees a significant decline in sales volume or profitability; or (2) FAW Group's proprietary brands incur significant losses on a sustained basis.

Although it is unlikely, we may lower the rating if we believe the likelihood of extraordinary support from the Chinese government to FAW Group falls below our current assessment.

We may revise the outlook on FAW Group to stable if the company maintains its EBITDA margin comfortably above 8%. This could happen if the production and sales volume of brands under FAW Group, especially for JVs with , normalize to pre-epidemic levels without compromising profitability over the next 12-24 months.

• Beijing Automotive Group Co. Ltd. and BAIC Motor Corp. Ltd.

We placed our 'BBB+' ratings on Beijing Automotive Group Co. Ltd. (BAG) and its core subsidiary BAIC Motor Corp. Ltd. on CreditWatch negative as we view BAG to have a thin rating buffer against weak auto demand.

As of late March, all plants at the company and its suppliers have resumed production. However, BAG's capacity is running low as compared with normal level. We expect utilization to pick up gradually together with demand from the second quarter, but a difficult operating environment would lower BAG's EBITDA margin by at least one to two percentage points in 2020. Moreover, BAG is exposed to global supply chain disruption, if its foreign suppliers suspend production for a prolonged period. We estimate that the company imports a considerable portion of auto components for its models mainly from Germany and U.S.

We think BAG's financial leverage, as measured by funds from operations (FFO)-to-debt ratio, may fall below 20% in 2020. There is also uncertainty over a meaningful recovery in 2021.

CREDITWATCH

The CreditWatch placement reflects our view that BAG's credit profile is under significant downward pressure given the rapid deterioration in industry conditions. We see increasing downside risks to the company's profit and leverage in 2020 given the weak demand outlook in China. The production suspension of the company's overseas auto suppliers also adds uncertainty to its operations. We plan to resolve the CreditWatch placement within 90 days after reviewing BAG's credit strengths based on its 2019 results and revising our updated forecasts of its financial performance in 2020-2021. We may lower the ratings on BAG by one notch if we believe its FFO-to-debt ratio will drop below 20% in 2020 and is unlikely to recover meaningfully in the year after. We continue to view BAIC Motor to be a core subsidiary of BAG and the issuer rating will move in tandem with that on BAG.

• Zhejiang Geely Holding Group Co. Ltd. and Geely Automobile Holdings Ltd.

We placed our 'BBB-' ratings on Zhejiang Geely Holding and its core subsidiary Geely Auto on CreditWatch negative as we believe the COVID-19 outbreak will weaken the companies' credit metrics in 2020. We think the company may record negative free cash flow in the year, pushing its debt to EBITDA above 2.0x.

Zhejiang Geely Holding's revenue will likely decline materially in 2020, as a result of weak demand and production disruption amid the pandemic. While Zhejiang Geely Holding's China businesses largely resumed operations by March with continued utilization ramp up, the group is taking another blow from production suspension at Car AB's plants in Europe and U.S. since mid-March and the potential disruption of imported auto components.

The group's EBITDA margin will further weaken in 2020, after an estimated decline of 1.5-2.5 percentage points in 2019, because of weak demand, intense competition, and extra costs for managing supply chain disruptions.

The ongoing merger between Geely Auto and Volvo could strengthen the company's competitiveness over the next few years. A potential equity placement may also help the group to deleverage, but the timing and magnitude remains uncertain.

CREDITWATCH

The CreditWatch placement with negative implications reflects our view that the credit profiles of Zhejiang Geely Holding and Geely Auto may not be able to tolerate the revenue and margin erosion brought by the COVID-19 pandemic.

We may lower the ratings on both Zhejiang Geely Holding and Geely Auto by one notch if we forecast Zhejiang Geely Holding's adjusted debt to EBITDA ratio to rise above 2.0x sustainably with a low likelihood of meaningful improvement. We may also lower the ratings if Zhejiang Geely Holding's adjusted EBITDA margin deteriorates to below 6% on a sustained basis. This may happen if Volvo Cars' operations are disrupted for a prolonged period or if there is no meaningful recovery in auto demand both in China and abroad.

We intend to resolve the CreditWatch placement within 90 days. Factoring in Zhejiang Geely Holding's release of its audited results for 2019 and the development of the pandemic, we will re-examine our-base case assumptions regarding Geely Auto and Volvo Cars' new car sales and their financial performances over the next one to two years.

Related Criteria

• General Criteria: Hybrid Capital: Methodology And Assumptions, July 1, 2019

• General Criteria: Group Rating Methodology, July 1, 2019

• Criteria | Corporates | General: Corporate Methodology: Ratios And Adjustments, April 1, 2019

• Criteria | Corporates | General: Reflecting Subordination Risk In Corporate Issue Ratings, March 28, 2018

• General Criteria: Guarantee Criteria, Oct. 21, 2016

• Criteria | Corporates | General: Methodology: The Impact Of Captive Finance Operations On Nonfinancial Corporate Issuers, Dec. 14, 2015

• General Criteria: Rating Government-Related Entities: Methodology And Assumptions, March 25, 2015

• Criteria | Corporates | General: Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Dec. 16, 2014

• General Criteria: Methodology: Industry Risk, Nov. 19, 2013

• General Criteria: Country Risk Assessment Methodology And Assumptions, Nov. 19, 2013

• Criteria | Corporates | Industrials: Key Credit Factors For The Auto And Commercial Vehicle Manufacturing Industry, Nov. 19, 2013

• Criteria | Corporates | General: Corporate Methodology, Nov. 19, 2013

• General Criteria: Methodology: Timeliness Of Payments: Grace Periods, Guarantees, And Use Of 'D' And 'SD' Ratings, Oct. 24, 2013

• General Criteria: Methodology: Management And Governance Credit Factors For Corporate Entities, Nov. 13, 2012 • General Criteria: Stand-Alone Credit Profiles: One Component Of A Rating, Oct. 1, 2010

• General Criteria: Use Of CreditWatch And Outlooks, Sept. 14, 2009

Related Research

• COVID-19 Will Batter Global Auto Sales And Credit Quality, March 23, 2020

• COVID-19 Macroeconomic Update: The Global Recession Is Here And Now, March 17, 2020

• Credit FAQ: How Are China's Industrial Producers And Construction Firms Holding Up Under The COVID-19 Outbreak?, March 9, 2020

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Primary Credit Analysts: Stephen Chan, Hong Kong (852) 2532-8088; [email protected]

Chloe Wang, Hong Kong + 852-25333548; [email protected]

Claire Yuan, Hong Kong (852) 2533-3542; [email protected]

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