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Cheng Shin Rubber Ind. Co. Ltd. Outlook Revised To Negative On Weaker Profitability, Rising Rating Affirmed

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TAIPEI--18 Dec--S&P Global Ratings

TAIPEI (S&P Global Ratings) Dec. 18, 2017--S&P Global Ratings said today it had revised its rating outlook on Cheng Shin Rubber Ind. Co. Ltd. (CST) to negative from stable. At the same time, we affirmed the 'BBB-' long-term corporate credit rating on the Taiwan-based company.

"The outlook revision reflects our view of the significant risk that CST's debt leverage could remain elevated with a ratio of debt to EBITDA above 2x over the next one to two years," said S&P Global Ratings credit analyst Raymond Hsu. "That's because slowing demand growth in China and intense competition could keep the company's profitability and cash flow relatively weak. However, in our base case scenario, we expect CST to moderately improve its profitability and lower its debt gradually over the next two years."

CST's profitability has weakened materially with its EBITDA margin falling to about 15% in the third quarter of 2017, from 24.2% in the same period of 2017, due to weak product pricing, a decline in the passenger car tire sales, depreciation of the Chinese renminbi (RMB), and volatile raw material costs. CST's debt has also increased materially beyond our previous expectation due to weakening profitability, continued capital expenditures, high dividend payments, and inventory buildups leading to working capital outflow. As a result, we expect the company's ratio of debt to EBITDA to deteriorate beyond 2x in 2017.

"We expect the slowdown in China's auto market to remain a risk for CST, which generates about 60% of its revenue from China," added Ms. Hsu. "We expect auto sales in China to decelerate substantially to 2%-4% in 2017-2019, compared with double-digit growth in 2016."

The slowdown in sales of mass-market cars in China has significantly affected CST's sales, which are concentrated in this segment. In addition, slowing demand has intensified competition and significantly eroded product margins.

Moreover, pricing competition in China's truck and bus tire market has intensified, partly because of weak domestic demand and the effect of anti-dumping taxes levied by the U.S. since September 2017. Chinese tire makers have sought more domestic sales and materially driven down product prices over the past 12 months. We expect market orders in the segment to improve and product prices to continue to recover over the next one to two years because heavy losses discourage output, particularly from small players. However, we expect competition to remain very intense and margins to remain under risk over the next the same period, given continued overcapacity in China.

Nonetheless, under our base case scenario, we expect CST to recover its profitability and sales over the next one two years supported by rising orders for new care models and diminishing inventory gluts at the company and its auto OEM clients, recovering truck and bus tire pricing, and CST's improving product and client mix. We also expect CST to gradually increase sales of premium tires for luxury cars, while the introduction of high performance tires with competitive pricing should help the company to recover revenue growth and product pricing.

In addition, we expect CST's new factories for motorcycle tires in India and Indonesia that were commissioned in 2017 to strengthen the company's revenue over the next one to two years, given its leadership in the global motorcycle tire market.

The rating affirmation reflects our base-case scenario that CST will improve its discretionary cash flow and lower its debt gradually over the next one to two years with improving profitability, better working capital management, and lower cash dividends and capital expenditures. We expect the company to improve its inventory turnover to cope with slower market growth. We also do not expect CST to take on major capacity expansion inside and outside of China after its recent expansion in Indonesia and India, and instead focus on improving the efficiency of its existing facilities such as through automation.

We also expect CST to pay lower cash dividends over the next two years because of its weaker profits and recently rising debt. Based on these factors, we expect CST to generate positive discretionary cash flow and lower its ratio of debt to EBITDA to 1.5x-2.0x in 2018-2019 from 2.0x-2.4x in 2017.

The negative outlook reflects the material risk that CST's profitability and free cash flow will remain weak over the next one to two years because of intense competition, slowing demand growth in China, and volatile raw material prices. These factors will cause the company's ratio of debt to EBITDA to stay above 2x for a prolonged period, despite our expectation that CST will lower its capital expenditure and cash dividend payout over the next one to two years.

We may lower the rating on CST if the company's profitability and cash flow do not improve and lower its debt gradually, such that that company's ratio of debt to EBITDA remains above 2x for an extended period. We may also lower the rating if CST fails to maintain its cost competitiveness or brand strength, and continues to lose market share. A persistent decline in the company's revenue and EBITDA margin relative to its peers' or an EBITDA margin below 15% for an extended period would indicate such deterioration.

We may revise the outlook to stable if CST strengthens its profitability and cash flow and lower its debt, with a ratio of debt to EBITDA below 2x on a sustainable basis. This could be achieved if the company recovers its passenger car tire sales, improves the margin on its truck and bus tire sales, and lowers its cash dividends without taking on significant capacity expansion.


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