Jiuzhong Financial News, Sept. 9, S & P confirmed that Shanghai Electric (Group) Corporation (Shanghai Electric (Group) Corp.) and its core subsidiary Shanghai Electric Group Co., Ltd. (Shanghai Electric Group Co. Ltd., referred to as "Shanghai Electric", 02727.HK601727.SH) have a long-term issuer credit rating of "A -". S & P also confirmed that the Shanghai Electric Corporation has a long-term issuance rating of "A -" for guaranteed senior unsecured bonds. S & P removed all ratings from its watch list and put ratings on negative impact credit watch on June 1, 2021.
The "negative" outlook reflects uncertainty about whether Shanghai Electric will be able to restore profits and reduce leverage from 2022. It also takes into account that the ability of the new management team to strengthen internal controls is still untested.
S & P confirmed the ratings of Shanghai Electric Corporation and Shanghai Electric because S & P believes government support will continue to strengthen their creditworthiness, although their credit strength has weakened on an independent basis. According to S & P's assessment, after absorbing a large amount of impairment losses in 2021, the financial indicators of the two companies will deteriorate significantly in 2021. The two companies should restore profits and reduce leverage from 2022. However, both also need to deal with slowing income growth and falling profit margins. At the same time, the efforts of the new management to strengthen internal controls are untested.
S & P believes that the huge risk of recovering accounts receivable will affect the independent credibility of Shanghai Electric Corporation and Shanghai Electric. S & P estimates that Shanghai Electric's EBITDA is close to break-even, while Shanghai Electric Corp.'s adjusted EBITDA will turn to a loss of about 1 billion yuan in 2021. By comparison, Shanghai Electric's EBITDA was 8.2 billion yuan in 2020, while Shanghai Electric's adjusted EBITDA was 6.4 billion yuan. S & P's assessment takes into account the loss of RMB 7.4 billion in accounts receivable and inventory provision from its subsidiary Shanghai Electric Communication Technology Co. Ltd., in which Shanghai Electric Corporation holds a 40 per cent stake in Shanghai Telecom and is the largest shareholder. S & P also saw uncertainty about the outlook for the recovery of the remaining 3.5 billion yuan of receivables and inventory exposures. This exposure is likely to further affect Shanghai Electric's financial results in the coming quarters, which S & P has not included in the basic case forecast. S & P believes that the group's legal action against Shanghai Telecom's direct customers, mainly state-owned enterprises, is likely to be long and unlikely to help make up for its losses. S & P said that while S & P considered the incident to be an isolated incident, the group's independent credibility had diminished. The rating review takes into account S & P's expectation of significant losses and rising debt levels this year, as well as internal management and governance deficiencies reflected in the Shanghai Telecom deal. As a result, S & P lowered Shanghai Electric's SACP from "bbb-" to "bb+" and Shanghai Electric's SACP from "bbb+" to "bbb".
The risk management of subsidiaries under the new management team has not yet been tested. The new management is likely to strengthen risk management and internal controls, especially in subsidiaries. The team said financial management had been strengthened after Shanghai Telecom had a large number of overdue accounts receivable. Shanghai Electric Corporation checked accounts receivable, inventory, shareholder loans and acquisition goodwill to detect potential risks. Shanghai Electric also decided to change the model in which the group has been expanding through investment since 2017. S & P believes that for at least the next two years, the group will significantly reduce its investment preferences and is likely to streamline some non-core businesses. A potential shift in strategy could help contain the debt that has accumulated rapidly over the past few years. This shows that the new management team needs time to strengthen its control over the portfolio of dozens of business units of the group in order to prevent the recurrence of incidents such as Shanghai Electric Communications and to form a healthy development record.
The income scale of Shanghai Electric Corporation may not change too much and tend to be stable in the next 12-24 months. In the past two or three years, the telecom business of Shanghai Electric Corporation has contributed only a single digit to the group's revenue, and S & P believes that the Shanghai Electric Communications incident has a limited impact on the group's core business strength. In other words, the revenue growth of Shanghai Electric Corporation will decline in the next few years. Despite the general decline in sales of traditional thermal power equipment, factors including continued acquisitions, the expansion of the product portfolio and the rapid expansion of the engineering and construction business contributed to compound annual revenue growth of more than 20 per cent between 2018 and 2020. In the first half of 2021, the group's revenue grew by another 17 per cent, mainly due to the rapid delivery and installation of offshore wind turbines before cutting subsidies at the end of the year. S & p estimates that shanghai electric's full-year revenue will grow by 5% and 10%.
However, given the significant decline in wind turbine sales and limited structural growth opportunities for other key products, Shanghai Electric's revenue is likely to fall by 5% in 2022. The company will continue to maintain a low growth rate in 2023. With risk management likely to tighten, the group is likely to take a more cautious approach to investment-driven businesses, such as some environmental protection EambiC and public-private partnerships. It will also limit the pace of income expansion. The group's overall business portfolio and satisfactory market position in key areas will support its annual revenue of 165 billion to 175 billion yuan in 2022-2023, compared with 161 billion yuan in 2020.
Shanghai Electric's profits will rebound from 2022, although it will be difficult for profit margins to return to pre-epidemic levels. Given that the company recorded most of the potential impairment of Shanghai Electric Communications in the first half of 2021, S & P estimates that the group's operating-related reserves could exceed 11 billion yuan in 2021 and normalize to 35-4 billion yuan from 2022, which is in line with 2020 levels. This will help the group's adjusted EBITDA rebound from next year. However, fierce competition, rising prices of raw materials, pricing pressure on a number of key products, adverse changes in product structure and increased contribution from the low-margin EcopC business may keep Shanghai Electric's mixed gross profit margin at 15%, 16%. This ratio is similar to 15.5 per cent in 2020, but far below the strong profitability of 18.5 per cent before the outbreak. The company has limited room to further cut administrative expenses and sales costs and needs to keep up with R & D investment. As a result, S & P predicts that Shanghai Electric Corp.'s adjusted EBITDA profit margin could return to 4.5 per cent Rue 5.5 per cent between 2022 and 2023, down from above 6.5 per cent before the outbreak.
S & P expects the debt level of Shanghai Electric Corporation to stabilize between 2021 and 2022. The aggressive expansion desire of Shanghai Electric Corporation and the integration of more leveraged acquisition targets have increased the group's interest-bearing borrowing from about 30 billion yuan at the end of 2017 to nearly 80 billion yuan by the end of 2020. With the group likely to shift to endogenous growth, S & P estimates that its adjusted debt is likely to stabilize at between 27 billion and 31 billion yuan in 2021-2022, compared with 28 billion yuan at the end of 2020. With tighter working capital management, the company is likely to reduce free cash outflows in 2021 and may moderately become regular from 2022. S & P also takes into account the company's land sales of about 8 billion yuan between 2021 and 2022, which is similar to the amount in the past two years. S & P believes that improved cash flow, asset disposal and equity financing activities of subsidiaries should help contain a sharp increase in debt between 2021 and 2022.
As debt and profits recover steadily, S & P estimates that Shanghai Electric's debt-to-EBITDA ratio could fall below 4.5 times from 2022. S & P believes that Shanghai Electric is likely to dispose of more assets and business than S & P's basic case, but there is a high degree of uncertainty in implementing any significant deleveraging plan. S & P estimates that Shanghai Electric's debt-to-EBITDA ratio could fall to less than double from 2022 to 0.4 times by 2020. Shanghai Electric's financial ratio will continue to be stronger than that of its parent company, as recent major debt financing investments and subsequent mergers have taken place at the parent company level. In addition, core subsidiaries continue to transfer underperforming assets to Shanghai Electric Corporation.
S & P still believes that Shanghai Electric is likely to receive special support from the Shanghai municipal government. The Shanghai Electric Communication incident reflects the defects in the management and governance of Shanghai Electric Corporation. Nevertheless, the company's core business remains robust and competitive, and S & P believes its market position in China's power equipment market remains intact.
S & P believes that in view of Shanghai Electric Corporation's leading position in the industry and its considerable scale, the company will continue to have very close ties with the Shanghai municipal government and play a very important role. The rapid appointment of a new management team by the local state-owned assets supervision and administration commission, continued capital injection, land sales by Shanghai Electric Corporation to the government and participation in recent investments coordinated by SASAC all attest to this close relationship. This led Shanghai Electric Corporation to upgrade its rating by four sub-levels on the basis of SACP.
S & P continues to regard Shanghai Electric as a core subsidiary of Shanghai Electric Corporation, and Shanghai Electric's rating will change in step with that of Shanghai Electric Corporation. Shanghai Electric accounts for more than 80% of Shanghai Electric's assets and revenue, and S & P expects Shanghai Electronics's contribution to remain at a similar level in the next two or three years.
Environmental, Social and Governance (ESG) Credit factors for Credit rating change: risk Management and Internal Control
The negative outlook of Shanghai Electric Corporation and Shanghai Electric reflects that there is still uncertainty about whether the two companies will be able to recover profits and reduce leverage from 2022 after making large losses in Shanghai Electric Communications this year. The significant impairment loss of Shanghai Electric Communications reflects the deficiency of the group in management and governance. The internal control and risk management capabilities of the new management team remain untested.
S & P may downgrade Shanghai Electric Corporation and Shanghai Electric if:
-other events indicating serious deficiencies in management and governance; or
-the debt / EBITDA ratio of Shanghai Electric Corporation has remained at more than 4 times for a long time, which may be due to aggressive debt financing for acquisitions or higher-than-expected working capital outflows; or
-the Group's business has been weakened by the deterioration in product competitiveness, resulting in a decline in profit margins in its main business units.
In addition, S & P may downgrade Shanghai Electric if it thinks it is less likely than before to receive special government support. A sharp reduction in the government's stake could mean that the company is less likely to win support in the future.
If Shanghai Electric's debt-to-EBITDA ratio continues to fall to less than four times, and its profit margins will not decline further compared to 2020 levels, S & P may adjust the outlook of Shanghai Electric Corporation and Shanghai Electric to stable. In addition, this may also happen if the Group can strengthen risk management and internal controls to enable the company to operate steadily for a long time under the leadership of the new management without major negative events.