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March 28 (The following statement was released by the rating agency)
Fitch Ratings has downgraded China-based watch
retailer Hengdeli Holdings Limited's (Hengdeli) Long-Term Issuer Default Rating
(IDR) and senior unsecured rating to 'BB' from 'BB+'. The Outlook is Stable.
The downgrade reflects Hengdeli's deteriorating credit metrics amid a weak
operating environment. It will be challenging for Hengdeli to demonstrate a
sustained strong recovery to its previous level in the medium term.
The Stable Outlook reflects Hengdeli's ability to maintain its strong business
positioning and sufficient liquidity position despite the current down cycle.
KEY RATING DRIVERS
Weak environment increases recovery uncertainties. China's overall weak consumer
sentiment and the government's anti-graft campaign in H213 continued to affect
Hengdeli's performance. The company's active reshuffling of its product mix to
fast-moving mid-range watches was not enough to offset the rapid decline in
high-end watches sales. The company's overall same-store-sales growth (SSSG) in
mainland China declined 7.1% in 2013 (H113: -7.5%) as high-end watch SSSG
contracted 18.5% (H113: -18.9%) while mid-range watch SSSG remained flat (+0.6%)
(H113: +0.6). Hengdeli's SSSG in mainland China and wholesale segment had
exhibited positive growth YTD Feb 2014. However, sales visibility of Hong Kong
operations remained weak. Fitch views uncertainties in the economic conditions
and the weak buying sentiment would continue to dampen Hengdeli's sales rebound
in the medium term.
Profitability Pressured by Slower Sales. Hengdeli's EBITDA margin narrowed to
8.32% in 2013 (2012: 11.51%) due to heavier sales discounting and increased
rental costs. Fitch estimated that one percentage point of decline was
attributed to margin dilution from its new Harvest Max business. Fitch expects
the company's EBITDA margin to demonstrate slight recovery to around 9%, which
is still lower than the previous level. A higher contribution from mid-segment
watches which yields stronger margins would improve Hengdeli's profitability in
2014, but this benefit would partially be offset by ongoing sales discounting.
Acquisition and Working Capital Increased Leverage. Hengdeli's high inventory
days of 223 days (H113: 225 days) and about CNY300m of acquisition costs drove
higher FFO adjusted net leverage of 3.5x in 2013 (H113: 3x). With Hengdeli
finalising its inventory mix adjustments towards more fast moving mid-end
products by 2014, Fitch expects some alleviation in working capital with
positive free cash flow generation; the company's leverage would trend below 3x
over the next 12-18 months.
Strong business positioning. Despite a weaker performance, Hengdeli's rating is
still supported by its leading market position in the Swiss watch retail sector
in China, its established distribution network and exclusive watch distribution
arrangements that support its wholesale business. In 2013, the company was able
to lengthen its days payables with suppliers in light of the weaker environment,
which is a reflection of the company's business positioning and close
relationship with its suppliers.
Adequate Liquidity. Hengdeli maintains sufficient cash of CNY2.3bn to cover its
short-term bank loans of CNY1.35bn and estimated capital expenditure of around
CNY150m for the next 12 months. The company also has CNY2bn in unutilised
facilities to bridge working capital purposes, if required. As expected, the
company had redeemed most of its convertible bonds in 2013, with outstanding
balance of HKD95m as at end-2013.
Negative: Future developments that may, individually or collectively, lead to
negative rating action include
-Negative SSSG for China
-Sustained weakening in EBITDA margins below 8%
-FFO adjusted net leverage sustained above 3.5x
Positive: Future developments that may, individually or collectively, lead to
positive rating action include
-Sustained EBITDA margin above 10%
-FFO adjusted net leverage sustained below 2.75x
-Average inventory days sustained below 210 days