HONG KONG, 5 December 2018. Pengyuan International has assigned a first-time global scale long-term issuer credit rating (LTICR) of ‘BBB’ to Shanghai Construction Group Company Limited (SHCG). The rating is based on a standalone credit profile (SACP) of ‘bbb-’, and one notch uplift due to the potential Shanghai municipal government support. The Outlook is Stable.

The rating reflects SHCG’s strong market position, a diverse business scope across value chain, and a resilient financial profile. In addition, the rating considers the moderately strong support from Shanghai municipal government. In our view, Shanghai government has a strong influence over SHCG’s long term strategies, and has moderately strong willingness to provide support SHCG in the event of financial distress.

However, these strengths are partially offset by its concentrated exposure in Shanghai region, weak profitability in a highly competitive business environment, and potentially high capex needs for its investment projects.

SHCG is a diversified contractor that operates across the construction value chain. The company is involved in construction contracting, property development, construction-related industry, investment and management of the public utilities and infrastructure businesses.

 

KEY RATING RATIONALES

Positive

Leading market position in Shanghai. Being ranked the 9th among top 250 global contractors in 2018 by Engineering News Record (ENR), SHCG has enjoyed dominant market shares and consistently participated over half of key infrastructure projects in Shanghai during the last five years. Leveraged on its expertise in the construction of high-rise buildings, and on the long track record of large projects construction which enables its easier access to various sources of financing, we expect SHCG continue to maintain its leading market position in the region.

Diverse business offering across value chain. SHCG is a well-diversified contractor that operates across the value chain of construction industry, including its core construction contracting, property development, and construction materials such as ready-mix concrete and fabrication of concrete elements. Product diversification helps SHCG mitigate cyclical cash flow from the construction business, and helps the company avoid overdependence on any particular segment. We believe it also helps the company to serve a diversified customer base, source from diversified suppliers, and contribute to a healthy revenue mix.

Strong liquidity on limited investment projects exposure. SHCG has a strong liquidity thanks to its high amount of liquid assets on hand and positive funds from operations. While some other contractor peers in China are engaged in more investment projects which require significant outlay of the working capital over extended periods due to the long pay-back period, SHCG’s exposure in these investment projects is comparatively small, which led to its stronger than peers’ liquidity, in our view.

External support from Shanghai government. Listed in Shanghai Stock Exchange and 53% owned by Shanghai State-owned Assets Supervision and Administration Commission (SASAC), SHCG received Shanghai municipal government supports in the form of subsidies, tax rebates and direct asset injections over the past few years. We see Shanghai SASAC has 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 projects and its technical strength in the construction of high-rise buildings in China supports its strategic importance to the government, in our view.

 

Negative

Concentration risk. SHCG has high concentration risk in terms of geography with over 50% of revenue and 58% of new contracts signed for construction contracting generated from Shanghai in 2017. In terms of new contracts signed for construction contracting, Shanghai, other provinces within China and overseas markets accounted for 58%, 40% and 2% of its total contracts respectively in 2017. We expect Shanghai will continue to be its major revenue source for the next 3 years, although the company may adopt a conservative approach to expand its operation into other regions.

Weak profitability. Similar to other peers, SHCG has a low EBITDA margin and return on invested capital (ROIC) in the highly competitive construction market. However, with higher mix of non-construction business, which carry higher profit margin than construction business, EBITDA margin increased to 4.2% in 2017, from 3.7% in 2016. We forecast revenue mix of non-construction business will further increase in the next few years, with ROIC gradually increase to 7.0%-7.4% in 2018-2020, from 6.0%-6.8% in 2016-17, on improved profitability. Despite that, its overall profitability is still weak, in our view.

High capex needs could be a potential overhang. New contracts signed for infrastructures investment segment, which mainly consist of public-private-partnership (PPP) and build-transfer (BT) projects, reached RMB 17.9 billion and RMB15.6 billion for 2016 and 2017 respectively, from RMB8.9 billion in 2015. To fund these investment projects, we estimate SHCG would need an average capex of RMB3,500 million annually for next 3 years. If SHCG continues to sign more of these investment projects, it may require a higher capex need, although its current exposure is not significant yet.

RATING OUTLOOK

The stable outlook reflects our expectation that SHCG will be able to maintain its operational strength in the industry, 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 evident by an increase in debt to EBITDA to above 2.7x with little perspective of deleveraging; 2) our assessment that 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 evident by a decrease in gross debt to total capitalization to below 57%, and an increase in EBITDA interest coverage to above 4.0x on a sustained basis; 2) our assessment that Shanghai government’s willingness of support to SHCG has strengthened materially.

 

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

ANALYSTS CONTACT

MEDIA CONTACT

OTHER ENQUIRIES

Primary Analyst

Brian Lam

+852 3615   8339

brian.lam@pyrating.com

 

Secondary Analyst

Simon Lee

+852 3615   8307

simon.lee@pyrating.com

 

Committee Chair

Tony Tang

+852 3615   8278

tony.tang@pyrating.com

 

media@pyrating.com

contact@pyrating.com

 

Date of Relevant Rating Committee: 21-22 November 2018

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)

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