S&P Lowers Outlook on China XD Plastics (CXDC) to Negative

Standard & Poor's Ratings Service said it revised its rating outlook on China XD Plastics Co. Ltd. (Nasdaq: CXDC) to negative from stable. In line with this revision, we lowered the long-term Greater China regional scale rating on the China-based auto application manufacturer to 'cnBB' from 'cnBB+'. At the same time, we affirmed the 'BB-' long-term corporate credit rating on the company. We lowered the long-term issue ratings on the outstanding senior unsecured notes that China XD Plastics guarantees to 'B+' from 'BB-' and the Greater China regional scale rating to 'cnBB-' from 'cnBB+'.

"We revised the outlook to reflect the significant downside risk that China XD Plastics faces over the next 12 months because of weak market conditions, intensifying competition, and possible delays in expansion projects," said Standard & Poor's credit analyst Apple Lo. "We believe these factors could weaken the company's EBITDA margin more than we previously anticipated and keep its ratio of debt to EBITDA consistently above 4x."

China XD Plastics' financial performance was much weaker than we had anticipated in 2015 and compared with 2014. The company's revenue declined 10% annually, the EBITDA margin fell to 16.5% from 17.7%, and the ratio of debt to EBITDA increased to 3.9x from 2.7x.

We expect China XD Plastics' profitability to remain under significant pressure over the next 12 months. The slowing growth in China's auto market and new capacity through the modified plastics market, including China XD Plastics' expansion in Sichuan, and market fragmentation could continue to erode prices and lower utilization. The company's concentrated customer base and limited operating scale could heighten the downside risk, given the currently difficult industry conditions. Accordingly, we expect the company's ratio of debt to EBITDA to be slightly higher than our downgrade trigger of 4.0x in 2016, which would suggest a financial risk profile that is weak for the rating.

We affirmed the corporate credit ratings because of China XD Plastics' strong cash position, with about US$240 million in unrestricted time deposits available for debt repayment. Further, we note that while the company's EBITDA margin has declined significantly over the past three years, it is still higher than industry peers' due to its low labor costs and operating efficiency. This is despite the company's narrow business scope and geographic diversification, and intense competition from its larger domestic and international peers.

The affirmation of the corporate credit ratings also reflects our base-case assumptions that China XD Plastics' ratio of debt to EBITDA could decrease below 4x over next 12-18 months. We expect the company's resumption of shipments to its Korean customers and the commissioning of new capacity to increase its revenue and cash flows even if margins decline due to price erosion. The base case also assumes that China XD Plastics can control its operating expenses and development costs, and maintain its adequate liquidity. Nonetheless, we recognize material downside risk to our forecast because of slowing demand and intensifying competition.

We lowered the rating on China XD Plastics' guaranteed notes by one notch because we believe subordination risk has risen without strong offsetting factors to fully mitigate the disadvantages that noteholders face. The company's priority liabilities increased to 61% of total consolidated assets in 2015, from 52% in 2014. This is above Standard & Poor's threshold of 30% for the rating on the senior debt of speculative-grade companies to be two notches lower than the corporate credit rating on the issuer.

However, we recognize that China XD Plastics' diversity in its operating assets through multiple subsidiaries could partly offset the disadvantage that noteholders face. In the event of insolvency, we believe the prospects for residual value remaining for the parent company's creditors improve because individual operating subsidiaries wind up with shortfalls and surpluses. Accordingly, the issue rating is therefore just one notch below the corporate credit rating.

We could lower the ratings if: (1) China XD Plastics' profitability weakens substantially because of competition or operational risks, such that the ratio of debt-to-EBITDA is above 4.0x on a sustained basis; or (2) the company's liquidity profile weakens, such that the ratio of the sources to uses of liquidity falls below 1.2x or we believe the company's relationship with banks or its credit standing deteriorates; or (3) the company's business risk profile weakens, an indication of which would be a failure to meet utilization and sales target, or EBITDA margins continuing to significantly decline.

We could revise the outlook to stable if China XD Plastics' ratio of debt to EBITDA remains substantially below 4.0x on a sustained basis. This could happen if the company resumes revenue growth, somewhat stabilizes margins, improves order intake, and gradually increases production at new facilities.

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