OREANDA-NEWS. Fitch Ratings has downgraded China-based rental auto group CAR Inc.'s (CAR) Long-Term Issuer Default Rating (IDR) and senior unsecured rating to 'BB' from 'BB+'. The Outlook is Negative. CAR's USD300m 6% notes due 2021 and USD500m 6.125% notes due 2020 have also been downgraded to 'BB' from 'BB+'.

The downgrade reflects the substantial and growing related-party transactions with CAR's affiliate UCAR Inc, which has a weak credit profile. The Negative Outlook reflects the rapidly changing regulatory and market environment in the industries in which CAR and UCAR operate, and the risk that CAR's transactions with UCAR will remain high.

KEY RATING DRIVERS

Significant, Growing Related-Party Transactions: Related-party transactions between CAR and UCAR reached 33% of total revenue in 2015, and are poised to grow further in 2016. In addition to existing vehicle rentals to UCAR, CAR announced on 29 June 2016 that it will sell its used vehicles to UCAR and use UCAR's repair and maintenance services. CAR's largest shareholder is UCAR Cayman, and its largest customer is UCAR Inc, a ride-sharing company preparing to list on China's New Third Board. Charles Lu, who is currently chairman of CAR's board, is the actual controller of both UCAR Cayman and UCAR Inc.

UCAR Raises Business Risk: UCAR China became CAR's largest customer in 2015, and accounted for more than one-third of rental revenue. At the same time, Fitch believes that UCAR's credit profile is weak: the company is a small #4 player in China's hyper-competitive and evolving ride-sharing industry, and has yet to break even on an EBITDA level. UCAR believes that regulatory developments in China may benefit UCAR's business-to-customer model, while the timing and details remain unclear. Fitch believes that there may be a major negative impact on CAR's operations if UCAR remains loss-making at the EBITDA level.

Slower Car Rentals Business: Growth in the short-term rentals business began to slow down in 2015, as inexpensive rides offered by Didi and Uber began to lure customers away from traditional rental cars. Excluding UCAR's contribution, revenue from short-term car rentals grew only by the high single digits in 2015, compared with 30% in 2014. Management says it is planning to launch new marketing initiatives to attract and retain customers in 2016, and is targeting 20% revenue growth for the year.

Financial Profile Remains Healthy: Fitch expects the company to turn FCF positive after cutting back its fleet-expansion plans. Fitch expects a net fleet addition of only 7000-8000 vehicles in 2016. We see FFO-adjusted net leverage peaking at 2.5x in 2016, and declining gradually over the next two to three years. CAR's liquidity is sufficient, as current cash and committed undrawn banking facilities are more than sufficient to cover its short-term obligations.

Share Buybacks Credit Negative: CAR announced a share buyback plan in early June, and has already spent more than HKD300m between early June and early July 2016. If the company continues at the current pace, the share buybacks may more than cancel out the projected positive FCF for the year. If the company fully exercises its mandate to repurchase 10% of shares outstanding, Fitch estimates that the buybacks may cost up to HKD1.8bn in cash, based on the current share price.

KEY ASSUMPTIONS

- Net rental fleet addition of 7,000 vehicles in 2016

- Stable RevPac (average daily rental revenue per short-term rental vehicle) and utilisation rate of 63%-64%

- Flattish revenue contribution from UCAR

- EBITDA and EBIT margins maintained at 2015 levels

- CNY800m cash outlay for share buybacks in 2016

- No common dividends

RATING SENSITIVITIES

Negative: Developments that may, individually or collectively, lead to negative rating action include:

- Closer ties with UCAR, including (but not limited to) higher revenue contribution and higher share ownership

- FFO-adjusted net leverage sustained above 3.0x

- EBITDA margin sustained below 45% (FY15: 50.7%)

- EBIT margin sustained below 20% (FY15: 30.9%)

- Sustained negative FCF after share buybacks.

Positive: Developments that may, individually or collectively, lead to the Outlook being revised to Stable include:

- UCAR generates sustained positive EBITDA

- Revenue contribution from UCAR sustained below 20%.