Dongling Group Inc. Co. Assigned #B# Outlook Stable

Stocks and Financial Services Press Releases Monday February 26, 2018 18:01
HONG KONG--26 Feb--S&P Global Ratings

HONG KONG (S&P Global Ratings) Feb. 26, 2018--S&P Global Ratings assigned its 'B' long-term corporate credit rating to China-based commodities mining, smelting, and distribution company Dongling Group Inc. Co. (Dongling Group). The outlook is stable. We also assigned our 'B-' long-term issue rating to a proposed issue of U.S. dollar-denominated senior unsecured bonds by Dong Bao International Co. Ltd., a wholly owned subsidiary of Dongling Group. Dongling Group provides an unconditional and irrevocable guarantee for the bonds.

Our rating reflects our view that Dongling Group's commodities distribution business is expanding from a small scale in a competitive market with low margins, and focuses on zinc and steel. The rating also reflects our expectation that the company's leverage will remain high and liquidity will be less than adequate in the next 12 months.

We expect Dongling Group's gross margin to remain very low due to the company's back-to-back business model. Dongling Group has been growing its commodities trading and distribution business through the increase in non-ferrous and steel trading. Despite weak commodity prices, the company's revenue growth has been considerable over the past few years. However, we consider Dongling Group's scale to be still small on a global basis, and expect the company's market share to be limited in the highly fragmented and competitive domestic China landscape. We do not anticipate that Dongling Group will aggressively expand its other business segments, such as smelting and property, and therefore assume that these segments will have a limited impact on the company's overall performance over the next two years.

Dongling Group's margins are also likely to remain thin because it primarily trades and distributes commodities, with limited value-added services. On the other hand, we expect margins to continue to have low volatility. The company does not take part in proprietary trading, and its buying and selling prices usually move in tandem, allowing for largely stable margins. As a result, the company has been able to maintain slim but positive margins in the past few years, despite volatility in underlying commodity prices.

Due to Dongling Group's small margins, the company's profits are highly dependent on the scale and scope of its operations. In our view, the concentration of its distribution business geographically in China, and primarily in three products (zinc, steel, and coal) is a constraint on scalability. As such, we assess Dongling Group's business risk profile as weak. However, the company's business concentration risk is tempered by its diversified supplier and customer base.

We consider Dongling Group to be highly leveraged. In the past three years, the company's ratio of debt to EBITDA was 5.2x–12.6x, and we forecast this ratio will remain above 5x in 2018. We expect leverage to remain high because the company's growth is likely to be primarily funded by debt, and a margin expansion is not in our forecast. Due to Dongling Group's back-to-back trading model, we view its key risk to be counterparty risk rather than price risk. Nonetheless, the company has a fair track record of managing working capital by maintaining a stable number of inventory days despite its growth over the past years.

Given the trading business is asset light and we do not expect Dongling Group to significantly expand its other businesses, we estimate the company's capital expenditure to remain modest at Chinese renminbi (RMB) 400 million-RMB500 million per year in the next two years.

The stable outlook reflects our view that Dongling Group will remain highly leveraged in the next 12 months because the company will continue to fund the expansion of its trading business through debt. We also expect the company's margins to remain relatively stable, given the back-to-back nature of its contracts. Dongling Group will continue to grow its trading volume, but this will be offset by lower selling prices, according to our assumptions, resulting in relatively stable operating cash flow.

We may consider downgrading Dongling Group if there is a significant deficit in liquidity. This could happen if the company's operating cash flow falls, its relationships with banks weaken, or its access to the capital markets becomes restricted. We could also lower our rating if the company materially increases its leverage.

We may upgrade Dongling Group if the company deleverages such that its debt-to-EBITDA ratio falls below 5.0x for a sustained period. This could happen if Dongling Group is able to expand its margins or reduce leverage in its trading business. However, we see limited upside potential in the next 12 months.


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