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

After an extended Lunar New Year holiday due to the health emergency, industrial producers in China have gradually resumed operations. S&P Global Ratings' channel checks show the majority of rated automakers, auto suppliers, and capital goods producers are back to work. Nonetheless, business is far from usual. Weak downstream demand, shortages of raw materials, and logistics disruptions are common constraints. Normal operations are even more out of reach for the engineering and construction (E&C) companies we rate, due to shortages of workers amid travel restriction and higher health concerns in this labor-intensive industry.

We believe revenue and margins will be hit hard in the first quarter for all of the above sectors. However, full-year effects will be less significant. In general, auto original equipment manufacturers (OEMs) and auto suppliers will see greater operational and financial challenges because slower disposable income growth will continue to weigh on consumer spending, especially big-ticket items. Demand prospects look brighter for capital goods producers, especially for wind-power equipment and late-cycle construction machinery. For E&C companies, we expect project commencement to accelerate gradually and issuers to speed up construction later in the year. In this article, we address questions about the impact of COVID-19 on these sectors, and how our rated issuers are coping.

Frequently Asked Questions

What's the China auto sales outlook for 2020?

We expect China's auto sales to decline by 5% from last year. This is revised down from our assumption of a 1%-2% growth back in September 2019 (see " Global Auto Sales Will Downshift Again In 2020," published on RatingsDirect on Feb. 27, 2020).

China's auto sales plunged 18% year on year (YoY) by volume in January 2020; however, this was mainly because the Lunar New Year fell in the first month of 2020, against February in 2019. The fallout from the virus outbreak hit auto consumption hardest in February--which saw retail auto sales plummet by nearly 90% YoY in the first 23 days of the month, according to the China Passenger Car Association. As of early March, only about 30% of dealers were operating, based on survey data from the China Automobile Dealers Association. We believe customer traffic is thin for those dealerships that reopened. OEMs and dealers are trying to boost sales online; however, this channel is unlikely to take off in a meaningful way.

We anticipate auto demand will gradually pick up from the second quarter onwards as pent-up demand gradually releases. It's possible the health crisis could lead certain consumers to advance their purchase plans, given that personal vehicles can facilitate more secure travel, away from congested mass-transit options.

In addition, favorable government policies may support auto sales. The Ministry of Commerce together with other authorities are discussing stimulus policies to stabilize auto consumption. The municipal governments of Foshan and Guangzhou, two cities in Guangdong province, have recently announced subsidies that would knock Chinese renminbi (RMB) 2,000-RMB10,000 (US$288-US$1,440) off the purchase price of each vehicle sold in local dealerships. There are also talks about further relaxation of long-standing purchase restrictions (generally for traffic- or pollution-control purposes) in cities such as Beijing and Shanghai.

What's the current production status for auto OEMs and when will production normalize?

Most of the OEMs we rate resumed operations by the week of Feb. 17, 2020. An exception is Dongfeng Motor Group Co. Ltd. (DFG), which has about half of its production capacity in Hubei, the center of the new coronavirus outbreak. Production in Hubei may resume this week, specifically from March 11, 2020.

Utilization rates are low for those plants in operation, mainly due to shortages of auto components. However, the situation is dynamic since auto suppliers are also gradually resuming production. Currently, OEMs are prioritizing car models whose inventories are running low. Labor is not a big constraint. Rated producers told us that a majority of their workers have returned to the factories, though some are subject to 14-day self-quarantines.

OEMs generally expect production to normalize gradually from March and April onwards, and that they can improve utilization rates to compensate for stoppages in the first quarter. Therefore, they still maintain their 2020 volume target that was set at the year start. However, we think a downward adjustment is possible given the dim outlook for auto demand. Hence our revised-down assumptions on industry sales.

Meanwhile, some OEMs are thinking of cutting or deferring planned capital expenditure (capex) moderately, so as to build a bigger liquidity buffer in the face of market uncertainty.

Table 1

Rated Chinese Auto OEMs' 2020 Sales Target - No Revision Yet
('000 units) 2019 sales 2020 sales target YoY % change Jan-2020 sales YoY % change
Beijing Automotive Group Co. Ltd. 2,259 2,260 0 N.A. N.A.
China FAW Group Co. Ltd. 3,462 3,810 10 353.0 18
Dongfeng Motor Group Co. Ltd. 2,931 3,158 8 225.7 (9)
Geely Automobile Holdings Ltd. 1,362 1,410 4 112.0 (28)
YoY--Year on year. OEM--Original equipment manufacturer. N.A.-- Not available. Source: Company reports, Wind, Gasgoo.
How will disruptions in production affect the ratings of the auto OEMs?

Many entities in the sector have buffers to withstand the disruption (see table 2), which we believe will be temporary. However, some are more vulnerable to the disruption.

Dongfeng Motor Group Co. Ltd.: We revised our outlook on DFG to negative from stable last Friday (March 6, 2020). About half of DFG's capacity is in Hubei province are still suspended. We believe inventories are running low for components and finished autos at DFG's joint venture plants with Honda and Nissan--the largest volume contributors to the company. DFG's Hubei-based suppliers are likely to resume production together with the company from March 11. We estimate that DFG's 2020 sales volumes will drop by 5%-6% YoY in 2020. We also forecast the EBITDA margin of its parent (on a proportionate consolidation basis) will fall to 7%-8% in the year before recovering to above 8% in 2021. The parent's margin is the rating driver for DFG.

Beijing Automotive Group Co. Ltd.: Inventories of components and finished autos are low, especially for Beijing Benz. The situation could improve in the next one to two weeks, because the company has asked the municipal governments in Beijing, Tianjin, and Hebei to help speed up production resumption for its auto suppliers. Nonetheless, the production suspension has reduced the rating buffer for the company. BAIC Motor Corp. Ltd. (BBB+/Negative/--) is a core subsidiary of Beijing Automotive Group. The rating on this entity is equalized to that on the parent company.

China FAW Group Co. Ltd.: We believe the company is less affected than peers' by production disruptions. While inventory of auto components is low, the finished auto inventory at the company's plants and dealerships, especially for FAW-Volkswagen car models (the major volume contributor), can last for one to two months. This helps to partially mitigate the impact of the components shortage. Meanwhile, government support also provides buffer to the rating.

Zhejiang Geely Holding Group Co. Ltd.: This OEM is more resilient to supply-chain disruption than other rated peers', in our view. Most of Geely's suppliers are located in regions near its key production bases in Zhejiang. The company reacted quickly to move inventory from the auto suppliers to its plants soon after the outbreak. Moreover, most of its suppliers have started production from mid-February. Despite downward pressure on margins, we believe the rating buffer will remain sturdy, given our view that sales should normalize from the second quarter and the company will cut capex to control leverage. Geely Automobile Holdings Ltd.(BBB-/Stable/--) is a core subsidiary of Zhejiang Geely Holding Group. The rating on this entity is equalized to the rating on its parent.

Table 2

Chinese Auto OEMs Rating Snapshot
Beijing Automotive Group Co. Ltd.

China FAW Group Co. Ltd.

Dongfeng Motor Group Co. Ltd.

Zhejiang Geely Holding Group Co. Ltd.

Business risk profile Fair Satisfactory Fair Fair
Financial risk profile Significant Minimal Minimal Intermediate
Stand-alone credit profile bb a- bbb bbb-
Likelihood of extraordinary government support Very high (+4 notches from SACP) High (+1 notch from SACP)
Entity status within group Core (+3 notches from SACP)
Issuer credit rating BBB+/Negative/-- A/Stable A/Negative BBB-/Stable
Downgrade trigger FFO/debt <20% EBITDA margin (excluding sales company of Toyota) <8%(1) or Debt/EBITDA ~ 1x Parent's proportionate EBITDA margin <8% or Debt/EBITDA ~ 1x (2) EBITDA margin <6% or Debt/EBITDA >=2x
S&P forecast (2019-2021)
EBITDA margin 9.0%-11.0% 8.3%-8.8% 9.0%-10.5% 8.0%-10.0%
Debt/EBITDA 2.3x-3.0x Net cash Net cash 1.2x-2.0x
FFO/debt 20.0%-28.0% Net cash Net cash 35.0%-60.0%
Note: We only included financial triggers in the downgrade trigger. (1) We forecast FAW's EBITDA margin (excluding sales company of Toyota) to be 10.0%-10.5% in 2019-2021. (2) We forecast the EBITDA margin of Dongfeng's parent company (under proportionate consolidation) to be 8.5%-9.0% in 2019, and decline to 7.5%-8.5% in 2020-2021. It will remain in net cash position. (3) BAIC Motor Co. Ltd. (BBB+/Negative/--) is a core subsidiary of Beijing Automotive Group. Its rating is equalized to the parent company's rating. (4) Geely Automobile Holdings Ltd. (BBB-/Stable/--) is a core subsidiary of Zhejiang Geely Holding Group. Its rating is equalized to the parent company's rating. FFO--Funds from operations. SACP--Stand-alone credit profile. Source: S&P Global Ratings.
How have rated auto suppliers been affected?

They are less affected by the outbreak in China due to their more geographically diversified operations. However, weak global auto demand will weigh on their revenue and margins. We now project a 3.6% YoY decrease in global light vehicle sales in 2020. Besides the 5% decline for China, we expect the U.S and Europe will each fall by 3%.

For the rated suppliers, production volume and revenue from China market ranges from 20%-70% (see table 3). As to the facilities in China, the majority of their plants have resumed production from Feb. 10, but utilization rates are low. Their overseas operations are normal.

Table 3

Rated Auto Suppliers Generally Have Diversified Geographical Exposure
Company Sector exposure by revenue Geographical exposure by revenue*
Nexteer Automotive Group Ltd. 100% auto parts 20% APAC (mainly China), 70% North America, 10% EMEASA
Johnson Electric Holdings Ltd. 80% auto parts and 20% capital goods 1/3 in China, 1/3 in Europe and 1/3 in North America
Pearl Holding III 50% auto parts, 50% capital goods 70% in Asia Pacific, 10% in US, 20% in other regions
Yanfeng Global Automotive Interior Systems Co. Ltd. 100% auto parts 50% APAC, 30% North America, 20% EMEA
*While a strict breakdown is not available, we estimate that revenue source aligns closely with location of production base. APAC--Asia Pacific. EMEA--Europe, Middle East, and Africa. EMEASA--EMEA + South America. Source: S&P Global Ratings, company reports.

Johnson Electric Holdings Ltd.: This motor and motion-systems specialist provides most of its China-produced auto parts to local OEMs. The company normally keeps two months of raw materials in inventory, and logistics is not a big issue at the moment. Its highly vertically integrated operations also reduce Johnson Electric's potential obstacles in sourcing raw materials. However, end-demand will be weaker than we originally expected. The company is likely to lower capex to better control its leverage.

Nexteer Automotive Group Ltd.: This steering and driveline-systems specialist has resumed operations in its four major plants in China. Roughly two-thirds of Nexteer's auto parts produced in China are sold to local OEMs and the output for these customers was fairly low in February due to the suspensions and disruptions. Nexteer's export business in China is much closer to business as usual. Our preliminary estimates indicate that disruptions in China's auto industry supply chain could reduce Nexteer's global revenue in 2020 by just 1%-2%. Given its strong balance sheet, including a net cash position, we view Nexteer as having sufficient rating buffer against the operational disruptions in China.

Yanfeng Global Automotive Interior Systems Co. Ltd.: The China production facilities of this supplier mostly reside next to OEM customers, and have mostly resumed production. Although raw material inventory is low, some are common parts and can be sourced from other existing suppliers. Businesses in North America and Europe are operating as usual, and they account for 50% of the company's total revenue. To facilitate free operating cash flow and maintain its leverage amid weak market demand, the company will likely lower capex and tighten working capital management.

Pearl Holding III Ltd.: Like its peers', Pearl also resumed production since the week of Feb. 10. Its utilization rate is low, mainly because many workers are in self-quarantine. Raw material inventories on hand are sufficient for 1.0-1.5 months of production. The company expects production to gradually normalize from March. It may lower planned capex at its Suzhou plant in light of the weak demand. For the non-auto parts business (see table 3), the company expects demand for consumer electronics and mobile to remain strong. Given Pearl's small business scale and high exposure to China, we think it is more vulnerable to the outbreak than its rated peers. With EBITDA interest coverage that we forecast as only slightly above 1.0x, the company's liquidity is the most important rating driver.

Table 4

Chinese Auto Suppliers' Rating Snapshot

Nexteer Automotive Group Ltd.

Johnson Electric Holdings Ltd.

Pearl Holding III

Yanfeng Global Automotive Interior Systems Co. Ltd.

Business risk profile Fair Fair Weak Fair
Financial risk profile Modest Modest Highly leveraged Modest
Stand-alone credit profile bbb- bbb b- bbb-
Issuer credit rating BBB-/Stable/-- BBB/Stable/-- B-/Negative/-- BBB-/Stable/--
Downgrade trigger Debt/EBITDA>1.5x Debt/EBITDA >1.5x EBITDA/interest< 1.0x Debt/EBITDA >1.5x or parent's EBITDA margin approaches 6% (1)
S&P forecast (2019-2021)
EBITDA margin 9.0%-11.0% 14.0%-14.5% 11.5%-12.5% 5.0%-6.0%
EBITDA/interest 7.5x-9.5x 23.0x-26.5x 1.2x-1.4x 17.0x-18.5x
Debt/EBITDA Net cash 0.7x-0.9x 8.0x-10.0x 0.4x-0.8x
(1) We forecast the EBITDA margin of Yanfeng's parent to be 8.5%-9.5% in 2019-2021 and the company to be in net cash position. Source: S&P Global Ratings
Will machinery and other capital goods companies be able to manage the impact of the outbreak?

To varying degrees, depending on the sub-sector of the rated issuers. Generally, the first quarter will be tough on revenue and margins. However, we anticipate wind-power equipment makers will see significant volume growth in 2020, due to rush installation ahead of subsidy cuts. Late-cycle construction machinery, such as concrete machinery, should continue to see decent demand and benefit from ongoing infrastructure construction.

Zoomlion Heavy Industry Science and Technology Co. Ltd.: This construction-machinery producer resumed production from Feb. 10, and its utilization rate has been ramping up. It also has sufficient finished goods inventory, which can support sales for up to a few months. The company expects to resolve components' shortages and logistics disruptions by mid-to-late March. In our view, the bigger threat to its performance is indirect, due to dampened downstream demand in the first quarter. Zoomlion expects China's construction activity to normalize from the second quarter. Meanwhile, we anticipate the company will continue to strictly control its credit sales and to focus on improving working capital.

Xinjiang Goldwind Science & Technology Co. Ltd.: Most of the company's plants have resumed operations. Its suppliers are also gradually firing up production, but supply is likely to be tight due to high demand as well as some logistics disruptions. After a stall in the first quarter, installation of wind power equipment should pick up significantly in the second and third quarters. This is because wind farms would like to rush installation before year end to qualify for government subsidies that are set to expire in 2021. We believe the full-year impact should be relatively small, and that demand for wind-turbine generators remains on track to reach a historical high. We also expect Goldwind's margins to improve this year because tendering prices have recovered from a recent nadir in March 2019. Meanwhile, we anticipate the company will continue to divest wind farm assets to better control its leverage.

Shanghai Electric (Group) Corp. (SEC): By late February, more than 80% of the company's subsidiaries had resumed operations. Given that most of SEC's power-equipment and industrial products have a relatively long production cycle of six to 12 months or more, temporary supply-chain disruptions might not derail demand and delivery. However, its E&C businesses and project-related equipment sales are more affected, especially in the first quarter. We estimate SEC's revenue could be largely flat or decline by a low single-digit percentage in 2020, versus our current base case of 3%-6% growth. While margins will likely face downward pressure during the year, the company's investment appetite and progress in executing planned asset disposal are more important rating drivers, in our view.

Weichai Power Co. Ltd.: The company's engine plants resumed operations in the week of Feb. 3, earlier than most capital goods manufacturers. Weichai has a few weeks of engine inventory on hand and focused its production in February mainly on stocking up on its self-made components and engines to prepare for the demand rebound in subsequent months. Weichai's subsidiary Shaanxi Heavy Auto's heavy duty truck plants resumed production in mid-February, though utilization rates remained low as a result of significant disruption to its end-market. We expect demand and production to pick up in March-April as China's construction and logistics activities gradually normalize. Moreover, Weichai will likely strengthen its market position due to its market leader status and supply chain resilience relative to peers. Its low leverage also provides financial buffer for the company.

CRRC Corp. Ltd. The majority--80%--of the company's operating subsidiaries resumed operations by late February. The significant drop in China railway passenger transport volume in the first quarter raises question marks over railway equipment demand in 2020, in our view. Yet the company may benefit if the government boosts railway investment to stabilize growth in the remainder of the year. We also view CRRC as having reasonable rating buffer given its very low leverage.

Table 5

Ratings Snapshots For China Machinery, Other Capital Goods Companies

CRRC Corp. Ltd.

Shanghai Electric (Group) Corp.

Weichai Power Co. Ltd.

Xinjiang Goldwind Science & Technology Co. Ltd.

Zoomlion Heavy Industry

Business risk profile Satisfactory Satisfactory Satisfactory Satisfactory Fair
Financial risk profile Minimal Modest Modest Significant Highly leveraged
Stand-alone credit profile a bbb+ bbb bbb- b
Issuer credit rating A+/Stable/-- A/Negative/-- BBB/Positive/-- BBB-/Negative/-- B/Positive/--
Downgrade trigger Debt/EBITDA >1.5x Debt/EBITDA >2.0x Market position weakens FFO/debt <20% Deleverage trend reversed
Upgrade trigger Higher sovereign rating Debt/EBITDA <2.0x Debt/EBITDA <1.5x FFO/debt >20% Debt/EBITDA <5x
S&P forecast (2019-2021)
EBITDA margin 9.0%-10.0% 7.5%-8.0% 11.0%-12.0% 10.0%-14.5% 12.5%-16.0%
Debt/EBITDA Net cash 1.7x-2.0x 0.4x-0.8x 3.0x-5.0x 2.5x-4.0x
FFO/Debt Net cash 35%-45% 120%-210% 10%-25% 12%-22%
FFO--Funds from operations. Source: S&P Global Ratings.
How are E&C companies holding up?

In our view, the construction industry in China faces a large but temporary blow. The sector companies we rate should be able to absorb the first-quarter disruptions and largely make up for lost time in subsequent quarters.

Some E&C companies resumed construction on selective projects from early to mid-February. These are mainly large-scale key infrastructure projects that have higher technical requirements or tight deadlines. Civil engineering and housing construction projects have been slower to commence. Overall construction activity is still low, partly because approvals for resuming projects have not been obtained, and partly because migrant workers are not fully in place. According to the Ministry of Transport, only about 40% of ongoing railway projects had resumed operations as of Feb. 25, and 37% of highway and waterway projects with investment above RMB1.0 billion.

Given delayed construction activity and a slowdown in tendering, E&C companies we rate will likely see considerable declines in revenue and new orders in the first quarter. Accounts receivable turnover days could lengthen for housing builders, if property developers seek payment extensions amid tight liquidity and declining presales. Having said that, the first quarter is the traditionally low season for construction activity in China due to the Lunar New Year holiday and cold weather. Revenue booking and new orders contracted in the first quarter normally only account for only about one-sixth to one-fifth of the full year total.

We expect construction activity to pick up from the second quarter onwards, in line with guidance from the State Council to local governments. The issuance of special-purpose bonds by local governments also provides funding support for projects to kick off. In the first two months of the year, local governments have issued a total of RMB950 billion in these special-purpose bonds, 67% of the funds are earmarked for infrastructure projects. We also anticipate new orders to edge up as more projects get released for tendering.

Considering the long cycle of infrastructure projects, we expect the rated issuers to be able to accelerate construction from the second quarter and to largely catch up with their completion targets. Companies with higher overseas exposure, such as Power Construction Corp. of China (about one-fourth of revenue generated overseas) seem less affected by the outbreak at the moment. However, risk is tilted to downside given the virus is spreading more widely to other regions. In addition, we believe that most of the rated E&C issuers, which are central or local state-owned enterprises, will continue to take other measures, such as mixed-ownership reform and debt-to-equity swaps, to meet their deleveraging targets for 2020. For example, China Railway Construction Corp. Ltd. announced plans in December 2019 to spin off its equipment manufacturing unit for listing on Shanghai's science and technology innovation board.

Table 6

Chinese Engineering And Construction Companies' Rating Snapshot
Company Issuer credit rating Downgrade trigger S&P forecasts (2019-2021)
China State Construction Engineering Corp. Ltd. A/Stable/-- Debt/EBITDA >= 3.5x OR EBITDA/interest <=4.5x Debt/EBITDA 3.1x-3.2x, EBITDA/interest 4.4x-4.8x
China Railway Construction Corp. Ltd. A-/Stable/-- FFO/debt close to 20% 24.5%-29.5%
China Railway Group Ltd. BBB+/Stable/-- Debt/EBITDA > 4x 1.9x-2.2x
China Metallurgical Group Corp. BBB+/Stable/-- EBITDA/interest < 2x 2.8x-3.6x
Metallurgical Corp. of China Ltd. BBB+/Stable/-- EBITDA/interest < 2x 2.4x-3.1x
Shanghai Construction Group Co. Ltd. BBB/Stable/-- FFO/debt declines to 20% 33.5%-37.5%
Power Construction Corp. of China BBB+/Negative/-- EBITDA/interest < 2x 2.0x
China State Construction International Holdings Ltd. BBB/Negative/-- FFO/debt < 20% 15.0%-23.0%
China Aluminum International Engineering Corp. Ltd. BB+/Negative/-- EBITDA/interest < 2x 1.7x-2.3x
FFO--Funds from operations. Source: S&P Global Ratings
What is S&P Global Ratings' house view on the overall economic impact of COVID-19 on China and globally, and how long will it last?

Reported COVID-19 cases continue to fall in China, suggesting containment is working albeit with high economic costs in the first quarter. Last week, S&P Global Ratings further revised down its estimate for China's 2020 real GDP growth, to 4.8%, and also cut global growth forecasts (see "Global Credit Conditions: COVID-19's Darkening Shadow," March 3, 2020).

While there continues to be high uncertainty about the rate of spread and timing of the peak of the COVID-19 disease, modeling by academics with expertise in epidemiology indicates a likely range for the peak of up to June 2020 globally. For the purpose of assessing the economic and credit implications, we assume the global outbreak will subside during the second quarter of 2020. As the situation evolves, we will update our assumptions and estimates accordingly.

Related Research

  • COVID-19 Now Threatens More Damage To Asia-Pacific, March 5, 2020
  • Global Credit Conditions: COVID-19's Darkening Shadow, March 3, 2020
  • Global Auto Sales Will Downshift Again In 2020, Feb. 27, 2020
  • Production Delay Will Weigh On Dongfeng Profitability , Feb. 17, 2020
  • Proposed Merger Could Give Geely A Volvo Car Lift , Feb.12, 2020
  • Coronavirus Outbreak A Test For China Corporates' Cash Flow And Liquidity, Feb. 12, 2020
  • Coronavirus In China: Domestic Auto Industry, Car Rental Companies Likely To Feel Impact In First Quarter, Jan. 31, 2020

This report does not constitute a rating action.

Primary Credit Analysts:Claire Yuan, Hong Kong (852) 2533-3542;
Lawrence Lu, CFA, Hong Kong (852) 2533-3517;
Stephen Chan, Hong Kong (852) 2532-8088;
Chloe Wang, Hong Kong + 852-25333548;
Yolanda Tan, Hong Kong (852) 2912-3006;
Secondary Contact:Torisa Tan, Shanghai (86) 21-3183-0642;
Additional Contacts:Sardonna Fong, Hong Kong + 6023586;
Rhett Wang, Hong Kong + 852-2912-3070;

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