HONG KONG, 5 December 2019. Pengyuan International has affirmed Shanghai Construction Group Company Limited (SHCG)’s global scale long-term issuer credit rating (LTICR) of ‘BBB’. The rating is based on a stand-alone credit profile (SACP) of ‘bbb-’, and an uplift of one notch due to the potential support from the Shanghai municipal government. The Outlook is Stable.

The rating reflects SHCG’s dominant market position in Shanghai and Pearl River Delta region, its diverse business scope across the construction industry and its resilient financial profile. The rating takes into consideration moderate support from the Shanghai municipal government. These strengths are partly offset by its concentrated exposure in Shanghai, weak profitability in a highly competitive business environment and the potentially high capital expenditure in its investment projects.

SHCG is a diversified construction contractor that is involved in the construction, investment and operation of urban infrastructure and public utilities. It specializes in the construction of high-rise buildings, bridges, industrial plants, public utilities and environmental protection projects. The company is also engaged in highway construction, electrical and mechanical equipment installation, blasting and demolition services.

 

KEY RATING RATIONALES


Credit Strengths

Leading player in Shanghai and Pearl River Delta (PRD) region.  Ranked 9th among the top 250 global contractors in 2019 by Engineering News Record (ENR), a provider of information on the engineering and construction industries, SHCG commands dominant market share in Shanghai and the PRD region, as evidenced by its revenue growth of 33% and 66% in Shanghai and the PRD region respectively during first half of 2019. On the back of SHCG’s long track record of large-scale construction, which gives it easier access to various sources of financing and its strong 20% growth in new contracts in first half of 2019, we expect SHCG to maintain its leading market position in these regions.


Products diversification. SHCG is a well-diversified contractor that operates across the value chain of the construction industry, including construction contracting, property development and construction materials such as ready-mix concrete and fabrication of concrete elements. Product diversification helps SHCG mitigate the cyclicality of cashflow from the construction business and avoid overdependence on any segment, thus minimizing its business risks. With revenue from its top five customers accounting for only 5% of total revenue in 2018, the company has a diversified customer base and healthy revenue mix.


Governmental support from Shanghai SASAC. Listed in the Shanghai Stock Exchange and 53% owned by the Shanghai State-owned Assets Supervision and Administration Commission (SASAC), SHCG has received government support in the form of subsidies, tax rebates and direct asset injections over the past few years. The Shanghai SASAC wields a strong influence over SHCG’s long-term strategies, by appointing board members and senior management to the company. SHCG has built more than half of Shanghai's key infrastructure projects. Its technical strength in the construction of high-rise buildings in China supports its strategic importance to the Shanghai government, in our view.


Strong liquidity. SHCG has strong liquidity thanks to its substantial liquid assets on hand and limited project investment exposure, resulting in positive cash inflow due to funds from operations. While many other large construction companies in China are engaged in many investment projects which require significant outlay of working capital over extended periods due to the long payback period, SHCG’s exposure to such investment projects is comparatively small, which has resulted in its liquidity being stronger than its peers, in our view.


Credit Weaknesses

Weak profitability.  SHCG has a low EBITDA margin of 4-5% and return on invested capital (ROIC) of 7-8% over the past few years. We forecast the revenue component of non-construction businesses will increase in the next few years, although construction will remain its core business in the next few years. Therefore, we expect the ROIC will gradually increase to 8.3% and 8.7% in 2019 and 2020 respectively from 6.0% and 6.8% in 2016 and 2017 respectively, due to improved profitability. Despite that, its overall profitability is still weak in our view.

 

High capex needs. The total value of new contracts signed for infrastructures investment segment, which mainly consisted of Public Private Partnership (PPP) and Build Transfer (BT) projects, reached RMB16 billion and RMB18 billion in 2016 and 2017 respectively, more than double the amount of RMB8.9 billion in 2015. To fund these investment projects, we estimate SHCG would need a capex of RMB3.5 billion annually for 2019 and 2020.

 

Concentration risk.  SHCG has a relatively high geographic concentration risk, with over 50% of revenue and 56% of new contracts signed for construction contracting generated from Shanghai in 2018. Shanghai, other Chinese provinces and overseas markets accounted for 56%, 42% and 2% of its total contracts respectively in 2018. We expect Shanghai will continue to be its major revenue source in the next 3 years, since the company may adopt a conservative approach in expanding to other regions.

 

RATING OUTLOOK

The stable outlook reflects our expectation that SHCG will be able to maintain its operational strength, and that Shanghai government will continue to provide support to SHCG over the next three years.

We would consider downgrading SHCG’s issuer credit rating if its credit profile deteriorates substantially, which could be caused by 1) material increase of leverage indicated by an increase in its debt to EBITDA ratio to above 2.7x with little prospects of deleveraging; 2) our assessment that the Shanghai government’s willingness of support to SHCG has weakened materially.

We would consider upgrading the company’s issuer credit rating if its credit profile improves substantially, which could be caused by 1) a reduction in leverage as indicated by a decrease in its gross debt to total capitalization ratio to below 57% and an increase in EBITDA interest coverage to above 4.0x on a sustained basis; 2) our assessment that the Shanghai government’s willingness to support SHCG has strengthened materially.


Note: ratings mentioned in this press release are unsolicited ratings.

ANALYSTS CONTACTMEDIA CONTACTOTHER ENQUIRIES

Primary Analyst

Brian Lam

+852 3615 8339

brian.lam@pyrating.com

media@pyrating.comcontact@pyrating.com


Secondary Analyst

Simon Lee

+852 3615 8307

simon.lee@pyrating.com




Committee Chair

Tony Tang

+852 3615 8278

tony.tang@pyrating.com




Date of Relevant Rating Committee: 22 November 2019

Additional information is available on www.pyrating.com


Related Criteria

General Corporate Rating Criteria (15 March 2018)

General Principles of Credit Ratings (21 Nov 2017)

Government-Related Entities Rating Criteria (31August 2018)

Corporate Financial Adjustments and Ratio Definitions (7 May 2018)


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