CAR Inc. Rating Downgraded To #BB# On Weaker-Than-Expected P Outlook Stable

Stocks and Financial Services Press Releases Monday August 21, 2017 15:43
HONG KONG--21 Aug--S&P Global Ratings

HONG KONG (S&P Global Ratings) Aug. 21, 2017--S&P Global Ratings today lowered its long-term corporate credit rating on China-based car rental company CAR Inc. to 'BB' from 'BB+'. The outlook is stable. We also lowered our long-term issue rating on CAR's outstanding senior unsecured notes to 'BB' from 'BB+'.

We lowered the ratings to reflect a significant decline in CAR's long-term fleet rental business, which, in our view, signals a deterioration in its competitive position. Since early 2017, the company has aggressively cut prices in the short-term rental business to try to gain market share. Although the move increased utilization, it also had a large negative impact on profitability. We therefore lowered our expectation of CAR's profitability over the next two years.

We believe fleet demand from UCAR Inc., as CAR's most important customer in long-term fleet rental business, will drop and that will directly affect CAR's overall rental revenue and EBIT margin. UCAR rents vehicles from CAR and contributed about 20% of rental revenue in the first half of 2017, a significant decline from 40% in 2016. Profitability in this business is higher than in short-term car rentals. The sharp decline in UCAR's revenue contribution caused CAR to change its business strategy by shifting its focus to other corporate customers, which lowers the overall earnings visibility of the company. We expect CAR to face high competition in the long-term fleet rental business, which creates uncertainties on the segment's growth.

We believe competition in the car rental business remains high even for market leaders such as CAR. This is evident from CAR's recent price cut in its short-term car rental business; its average daily rental rate declined to Chinese renminbi (RMB) 234 in the first half of 2017 from RMB307 in the same period of 2016. CAR is targeting a further increase in market share. In our view, the company is able to maintain a stable growth of its car short-term rental revenue by improving fleet utilization and rental days. But this will potentially pressure the residual value of existing fleet and its depreciation expense.

Despite the cross-holding structure with UCAR, we expect CAR to remain operational and financially independent. CAR's recent share buyback scheme will trigger shareholding increase by its existing shareholders, including UCAR. However, we expect UCAR to ensure that its shareholding in CAR remains below 30% and maintain CAR's listing status. CAR's total related-party transactions with UCAR on long-term fleet rentals and used-car disposals are well disclosed and we do not expect any further increase of related-party transactions over the next 12 months.

We revised our base-case assumption due to changes in CAR's long-term fleet rental business and pricing strategy, which lowered profitability. We lowered our projection for EBIT interest coverage to 2.1x-2.6x for the next 12 months, from 3.5x-4.0x previously. This reflects the company's declined EBIT margin and increased finance cost on an elevated debt level. The downward revision reflects our expectation of lower earnings contribution from the long-term fleet rental business and aggressive price competition in the short-term rental business.

In our forecast, CAR will keep expanding fleet size to feed vehicle retirement and rental growth. The total number of vehicles will grow by 10,000–15,000 each year in 2017 and 2018. We estimate that CAR's net capital spending for fleet expansion will stay at RMB2.5 billion–RMB3.0 billion in the coming 12 months. At the same time, we believe the company will refrain from making aggressive debt-funded acquisitions or investments in the next 24 months. As a result, CAR's free operating cash flow should improve and allow the company to deleverage.

The stable outlook reflects our view that CAR will be able to stabilize its profitability and interest servicing capacity while holding its market position over the next 12 months. The outlook also reflects our expectation that CAR will keep an independent operation from UCAR and continue to lower the number of related-party transactions.

Rating downside is unlikely in the coming 12 months. We could lower the rating on CAR if we believe UCAR exerts a high degree of control over CAR, or the companies become more economically entwined. This is based on our assumption that the combined entity will have meaningfully weaker credit measures, thus capping CAR's credit profile. A further increase in related-party transactions or earnings contributions from UCAR to CAR would indicate such a trend.

We also could lower the rating if CAR's EBIT interest coverage falls below 1.3x. This could happen if: (1) the company makes material debt-funded expansions or acquisitions; or (2) operating efficiency of its car rental

business deteriorates, which signals weakening competitive position and leads to significant erosion in profitability.
We could raise the rating if the company executes its growth strategy in China and demonstrates a record of prudent management while maintaining its operating margin and financial strength.

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