Fitch Ratings has assigned China-based Wens Foodstuff Group Co., Ltd.'s (BBB+/Stable) proposed US dollar senior notes a 'BBB+' rating.

The proposed notes, to be issued directly by Wens, are rated at the same level as Wens' senior unsecured rating as they will constitute the company's direct and senior unsecured obligations. The proceeds of the notes will be used to fund working capital, capex and debt repayment.

Wens' ratings reflect the company's leading position in the hog and broiler production markets in China, diversification in different protein types and a strong financial profile with high margins, low leverage and robust debt coverage. However, hog prices in China are volatile due to a fragmented market and lengthy production cycle, with smaller farmers unable to adjust capacity in a timely fashion. This has led to volatile operating EBITDA margins and free cash flow generation for Wens, which constrain the ratings at the current level.

KEY RATING DRIVERS

Stable Margin: Fitch expects Wens' operating EBITDA margin to stay strong at around 20% in 2020, as we forecast hog prices will remain high for the rest of 2020 due to a slow supply recovery. Chinese hog prices tripled due to inadequate supply, keeping Wens' operating EBITDA margins high at 23.1% in 2019 and 18.3% in 1H20. The price gain outpaced the rise in Wens' production costs. Weak downstream demand dampened the broiler margin and caused a 1H20 gross net loss, but this was offset by the high hog margin.

Low Leverage: Fitch expects Wens to continue to have low FFO net leverage and strong interest coverage, supported by robust cash flow generation. We estimate FFO net leverage will remain around 1x under a mid-cycle scenario. Free cash flow is likely to be moderately negative over the rating horizon of 2020-2023 due to large capex and dividend payments.

New Business Model: The company plans to build 'Company plus Farming Communities', where Wens owns the land and fixed assets while farmers are responsible for hog finishing. This differs from Wens' existing business model where farmers provide both labour and fixed assets. We expect better production efficiency, improved sanitation standards to prevent African swine fever (ASF) and lower fees paid to farmers as a result. The two business models will coexist, according to the company.

Capex to Accelerate: Fitch expects Wens to revamp its breeding facilities to improve efficiency and increase breeding sow inventory to capture growth opportunities. Fitch also expects Wens to expand its capacity for the poultry and processing business as the company seeks to diversify its business. The plan to build farming communities will also increase capex as more investments in fixed assets are required. Wens' current fixed assets and breeding sows can support annual production of up to 36 million hogs.

The company's capex may be flexible as some of it is related to the addition of capacity, which can be adjusted based on market conditions. We estimate annual capex of between CNY14 billion and CNY20 billion in 2020-2023.

ASF Remains a Threat: The threat of another ASF outbreak remains due to the absence of an effective vaccine, but Wens' diversification helps to mitigate risks from a large disease outbreak. In addition, we expect Wens to benefit from consolidation in the hog-breeding industry in China as smaller players are more vulnerable to disease outbreaks.

The sow inventory in China remains at record lows after the ASF outbreak in 2H18, despite a moderate recovery since October 2019. Wens' sow inventory fell in 2019 as the company eliminated unhealthy and low-productivity sows to improve quality and efficiency of breeding livestock. The company sold in total 7.1 million heads of hogs in 9M20 compared with around 18.5 million heads in 2019.

Diversified Animal Producer: Wens' ratings continue to be supported by its position as one of the largest hog producers in China with a market share of 3.4% in 2019. The company is also the largest yellow-feathered broiler chicken producer in the world by volume. Fitch expects Wens' diversification in protein types to continue to mitigate the cyclicality in each protein product. The company's diversified production venues across China also support the rating.

DERIVATION SUMMARY

Fitch considers Wens' credit profile to be in line with other global protein producers rated in the 'BBB' category, mainly due to the company's large operating scale, diversification in protein types, operations that are spread across China and modest leverage. The company's ratings are constrained by the volatility in its margin and free cash flow through the industry cycle.

Wens' rating is comparable with that of its protein-producing peer, WH Group Limited (BBB+/Stable), in terms of business profile. WH Group has stronger geographical and business line diversification due to its businesses in US, China and Europe, and presence in the full value chain from upstream farming to downstream processing and packaging. Wens has better diversification in protein type than WH Group. The two companies hold strong leadership positions in their markets. They also have similar strength in their financial profiles. WH Group has moderately higher leverage, but its positive free cash flow helps it remain on a deleveraging path. Wens has modest leverage, which means its slightly negative free cash flow caused by expansionary capex can be tolerated at the current rating.

Tyson Foods, Inc. (BBB/Negative) has a stronger business profile than Wens given Tyson's leading position in several protein categories and its stronger international presence. Fitch believes Wens has a stronger financial profile than Tyson, mainly due to Wens' consistently lower leverage. Wens' operating EBITDA margin remained higher than Tyson's even during the bottom of its cycle.

KEY ASSUMPTIONS

Fitch's Key Assumptions Within Our Rating Case for the Issuer

Flattish revenue in 2020 due to decline in hog production volume and broiler prices but offset by high hog prices; moderate growth from 2021.

EBITDA margin of 17%-22% in 2020-2023

Capex of CNY14 billion-CNY20 billion per year in 2020-2023

Dividend payout ratio at 40% of previous year's net profit

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to negative rating action/downgrade:

FFO net leverage sustained above 1x.

Operating EBITDA margin sustained below 15%.

Significant disruption to the company's operations due to ASF outbreaks, which will be evident in a sustained decline in production volume, for instance.

Factors that could, individually or collectively, lead to positive rating action/upgrade:

The rating is capped at 'BBB+' due to the fragmented nature of the hog-breeding industry.

BEST/WORST CASE RATING SCENARIO

International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.

LIQUIDITY AND DEBT STRUCTURE

Adequate Liquidity: Wens held readily available cash of CNY3.4 billion (including 70% of the value invested in wealth-management products, which we deem readily available), which was not sufficient to fully repay its outstanding short-term debt obligation of CNY5.1 billion at end-June 2020. We expect the company to utilise its CNY15 billion in undrawn bank facilities (comprehensive credit lines including cash loans and trade facilities) and tap bond markets to repay and refinance debt.

SUMMARY OF FINANCIAL ADJUSTMENTS

Adjustment to Cash: 70% of the value in the wealth-management products (non-principle guaranteed) has been classified as readily available cash. The rest are classified as restricted cash.

DATE OF RELEVANT COMMITTEE

10 June 2020

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

ESG CONSIDERATIONS

Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg

RATING ACTIONS

ENTITY/DEBT	RATING

Wens Foodstuff Group Co., Ltd.

senior unsecured

LT	BBB+ 	New Rating

VIEW ADDITIONAL RATING DETAILS

Additional information is available on www.fitchratings.com

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