(The following was released by the rating agency)\
HONG KONG, January 16 (Fitch) Fitch Ratings has published
China-based Hengdeli Holdings Limited's (Hengdeli) Long-Term
Issuer Default Rating (IDR) of 'BB+' with Stable Outlook. The
agency has also published Hengdeli's senior unsecured rating of
'BB+'. The company is a retailer for Swiss watches in China.
In addition, Fitch has assigned Hengdeli's proposed
USD-denominated senior unsecured notes an expected 'BB+(EXP)'
rating. The final rating is contingent upon the receipt of final
documents conforming to information already received. The
ratings reflect Hengdeli's exposure to cyclical demand for
watches and inventory risk.
The ratings also reflect its leading market position in the
Swiss watch retail sector in China, its exclusive watch
distribution arrangements for selected Swiss brands and its
established distribution network. Fitch estimates Hengdeli to
have captured a combined market share of around 25% for Swiss
watch sales in mainland China and Hong Kong in 2011. This large
operating scale gives Hengdeli strong bargaining power with
major global watch brand owners for new stock supply and in
negotiating rental or securing new retail location.
The risk of non-renewal of its distribution agreements is
mitigated by Hengdeli's strong bargaining power and watch brand
owners' strategy to tap China's long-term demand growth.
Hengdeli also benefits from low fixed costs and operational
flexibility, including an ability to reduce stock purchases when
The ratings are moderated by Hengdeli's exposure to cyclical
demand for watches, which can lead to rising inventory risk. Its
days inventory lengthened to about 220 days during H112 from 167
days in 2011 when sales slowed at its mature stores in China and
in Hong Kong, where the focus is on premium brands. Fitch
expects inventory days to gradually normalise as the company
cuts back on orders and adjusts its product mix in favour of
more fast-moving items.
The proposed senior unsecured notes would increase
Hengdeli's funds from operations (FFO) net adjusted leverage to
above 2x for the next two years (2011: 1.49x), a level that is
still commensurate with its rating. Fitch expects Hengdeli to
report positive free cash flow in 2013 after taking into account
likely moderate improvement in its cash cycle and capex
averaging at CNY300m per annum. The company is planning to use
the notes proceeds to refinance its out-of-the-money CNY2.5bn
bonds when they become due for conversion in October 2013.
Failure to refinance the convertible bonds would put pressure on
liquidity, although this is not Fitch's base-case scenario.
What could trigger a rating action?
Negative: Future developments that may, individually or
collectively, lead to negative rating action include:
-Inventory days being sustained over 220 days
-FFO net adjusted leverage rising above 2.75x on a sustained
-Weakening of Hengdeli's current leading market position
-Material negative change to key distribution agreements
with major suppliers
Positive: No positive rating action is expected unless
Hengdeli is able to substantially increase its scale without
compromising its financial metrics. This is not expected over
the next 2 years.