Xinjiang Guanghui:Initiate on GUANGH 7.875%2020s with Buy

We already have existing coverage of China Grand Automotive Services,having a Buy rating on CHGRAU 5.625% PerpC20s (ask price: 99.5, YTC: 5.8%,G+382bp) and a Hold rating on CHGRAU 8.75% PerpC19s (ask price: 106.5,YTC: 5.2%, G+328bp). Xinjiang Guanghui (GUANGH), its more highly levered,private parent company (with our calculated total debt/LTM EBITDA of 8.8x vs.

    CHGRAU’s 5.7x at end-June, 2017) is one of the few China holding companiesin the HY space that came to the market in the last two years. Shandong Ruyi(RUYIGR, bond ratings of B3/B- by Moody’s/S&P) and Tunghsu (DONGXU,bond ratings of B/B+ by S&P/Fitch) are the other two China private holdingcompanies which have issued USD bonds in the past 12 months. GUANGH7.875% USD300mn 2020s (issue ratings of B3/B- by Moody’s/S&P) trade atask price of 100.125, YTM: 7.8%, Z+570bp as we write, and look attractive tous vs. peers. We initiate on GUANGH 2020s with a Buy rating -- we like thisshort-dated bond (only 2 years and 3 months to go till maturity) which offer ahigh YTM of 7.8% and while Xinjiang Guanghui is highly levered with tightliquidity, we believe fundamentals have bottomed. Despite having highonshore bond maturity in 2018, Xinjiang Guanghui has also received approvalfor onshore bond issuance. Together with our expectations of good EBITDAgrowth in China Grand Auto and Guanghui Energy in 2H17 and 2018, weexpect Xinjiang Guanghui to be able to maintain its existing credit ratings in2018.

    Xinjiang Guanghui has received approval for issuance of up to RMB3bn of onshorepublic corporate bonds. We believe the execution of on-shore bondswould provide more liquidity to the company, though the on-shore yields arequite high these days. Furthermore, we expect CHGRAU and GuanghuiEnergy’s upcoming results to be good, given operational improvements.

    Credit positives: 1) A diversified business model, with various differentbusinesses including auto dealerships, property, energy, and logistics; 2)GUANGH is the largest shareholder (holding a 32.7% equity interest post-Dec’sequity placement by CHGRAU) in China Grand Automotive Services(600297.CH), the largest auto dealer in China by revenue which possesses awide range of brand offerings and has a wide dealership network; 3) XinjiangGuanghui was ranked No. 495 in the 2017 announced Fortune 500 list and isone of the biggest non-SOE companies in Xinjiang. The company is animportant employer in Xinjiang; 4) recovery in commodities, which has helpedGuanghui Energy’s operations and margins.

    Credit negatives: 1) private holding company status, which may mean lesscorporate transparency and corporate access activities, but the company doesfile periodic financials due to having onshore bonds; 2) tight liquidity(especially at the hold co level) and unfavorable debt maturity profile (i.e., highportion of short-term borrowings); 3) high leverage, partly drive by aggressivedebt-funded expansion in the past, however, we expect its leverage to modestly improve in the next two years; 4) a lack of majority stake in ChinaGrand Automotive Services, though we expect the company to remain as thelargest shareholder in CHGRAU. Xinjiang Guanghui also does not getmeaningful dividends from CHGRAU.

    In the China hold co space, DB analyst Vikash Agarwalla has a Buy onShandong Ruyi 2019s (ask price: 101.0, YTM: 6.9%, Z+485bp) & 2022C20s(ask price: 94.625, YTW: 8.4%, Z+616bp). GUANGH and RUYIGR USD bondsare all rated B3/B- by Moody’s/S&P, but we believe GUANGH 2020s shouldtrade about 50bp wider in spreads than RUYIGR 2019s (the former is 3.4months longer in maturity), given Ruyi’s business is less capex-intensive, hashigher GPM, and stronger liquidity than GUANGH. GUANGH has largerconsolidated revenue and EBITDA size, but posted slightly higher leverage(end-1H17’s total debt/EBITDA was 8.8x vs. Ruyi’s 7.4x) and similar EBITDAmargins in 1H17. Downside risks to our recommendation on GUANGH20sinclude more aggressive acquisitions, any unexpected leverage or margin dragby energy operations, and worse-than-expected liquidity or refinancing.