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Fitch Maintains Negative Watch on Hengdeli
February 24, 2017 / 9:14 AM / 8 months ago

Fitch Maintains Negative Watch on Hengdeli

(The following statement was released by the rating agency) HONG KONG/SHANGHAI, February 24 (Fitch) Fitch Ratings has maintained the Rating Watch Negative (RWN) on Hengdeli Holdings Limited's Long-Term Issuer Default Rating (IDR) of 'B+' and its senior unsecured rating of 'B+' with Recovery Rating of 'RR4'. Resolution of the RWN hinges on the outcome of an extraordinary general meeting (EGM) of shareholders regarding a proposal to dispose of its core operations. Fitch expects Hengdeli's operating scale to be substantially reduced should the disposal be completed, and therefore no longer justify the 'B+' rating. KEY RATING DRIVERS Persistent Market Weakness: Hengdeli's sales continued to decline in all its markets in 1H16. Revenue of the retail businesses in Hong Kong and China dropped by 16% and 10% yoy, respectively. In particular, revenue of Harvest Max, the retailer selling jewellery and low- to mid-end watches in Hong Kong, plunged by 45% as tourist arrivals remained sluggish. Despite the recent pick up in luxury spending in Hong Kong and China, Fitch does not expect a sustained recovery of luxury watch spending as the market seems to be fundamentally changed by the persistent economic slowdown and new retail formats. Asset Disposal Uncertain: Hengdeli announced at the end of 2016 it planned to dispose of Xinyu Group, the retail and wholesale operations in China, and Harvest Max. The proposal is subject to independent shareholders' approval at the EGM, which Fitch expects to be held in late March at earliest. The two assets accounted for approximately 80% of total revenue in 2015. A sale of the assets will inject abundant liquidity that Hengdeli will use to reduce debt substantially, but at the cost of a severe shrinkage in operating scale and the loss of its position as the market leader in the retail of Swiss watches in China. Continued Margin Pressure: Hengdeli's gross profit margin narrowed to 27.2% in 1H16, from 28.1% in 2H15 and 30.5% in 1H15, primarily due to higher sales discounts in an attempt to clear inventory. EBITDA margin remained flat at 6.2% in 1H16 due to controls on distribution costs. Fitch expects Hengdeli's EBITDA margin to narrow to about 5% in the next two years amid the weak market demand. DERIVATION SUMMARY Hengdeli is weaker in terms of scale, profitability and interest coverage than other Fitch-rated retailing peers like Lifestyle International Holdings Limited (BB+/Negative) and Golden Eagle Retail Group Limited (BB-/Negative). Hengdeli has a larger operating scale and stronger market position than Parkson Retail Group Limited (B-/Negative), but only if it retains the Xinyu Group and Harvest Max operations. Hengdeli has thinner margin, lower interest coverage and higher leverage than Reward Science And Technology Industry Group Co., Ltd. (B+/Stable), a consumer company in China that is rated at the same level. Hengdeli may improve its leverage by using the disposal proceeds to repay borrowings, although this will weaken its business profile. KEY ASSUMPTIONS Fitch's key assumptions within the rating case for Hengdeli include: - Lower gross margins for different business segments - Mid- to high-single-digit percentage decline in sales in 2017-2018 due to sustained market weakness - Lower annual capex budget RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to Negative Rating Action - The proposed disposal of Xinyu Group and Harvest Max is approved at the EGM - Sustained weakening in EBITDA margin to below 5% - Persistent and material sales contraction in China and Hong Kong - FFO fixed-charge coverage sustained below 1.7x Should the proposed disposal of Xinyu Group and Harvest Max be rejected at the EGM, Fitch will affirm the ratings at 'B+' with Stable Outlook. LIQUIDITY Worsening Liquidity Position: Hengdeli reported cash of CNY2.1bn and current borrowings of CNY2.2bn at end-June 2016. This compared with cash of CNY1.9bn and current borrowings of CNY704m at end-2015. Fitch expects the company to face challenges in its financial flexibility given the deteriorating profitability and shortening debt maturity, though there is no near-term liquidity risk as Hengdeli has unutilised bank facilities of over CNY4bn. Besides, it has cut its capital expenditure to CNY29m in 1H16 (2015: CNY159m), and Fitch expects the spending budget to continue to be conservative in the next few years. Contact: Primary Analyst Cathy Chao Associate Director +852 2263 9967 Fitch (Hong Kong) Limited 19/F Man Yee Building 68 Des Voeux Road Central, Hong Kong Secondary Analyst Yi Zhang Analyst +86 21 5097 3390 Committee Chairperson Kalai Pillay Senior Director +65 6796 7221 Media Relations: Wai-Lun Wan, Hong Kong, Tel: +852 2263 9935, Email: wailun.wan@fitchratings.com. Additional information is available on www.fitchratings.com. For regulatory purposes in various jurisdictions, the supervisory analyst named above is deemed to be the primary analyst for this issuer; the principal analyst is deemed to be the secondary Applicable Criteria Criteria for Rating Non-Financial Corporates (pub. 27 Sep 2016) here Additional Disclosures Solicitation Status here Endorsement Policy here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEB SITE AT WWW.FITCHRATINGS.COM. PUBLISHED RATINGS, CRITERIA, AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. 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