May 13, 2020 / 3:32 AM / 24 days ago

Fitch Downgrades Meinian to 'BB-'; Outlook Stable

(The following statement was released by the rating agency)

Fitch Ratings-Hong Kong-May 12:

Fitch Ratings has downgraded China-based preventive health examination services provider Meinian Onehealth Healthcare Holdings Co., Ltd.’s (Meinian) Long-Term Issuer Default Rating (IDR) and senior unsecured rating to ‘BB-‘ from ‘BB’. The Outlook is Stable.

Fitch has also downgraded the rating on Meinian’s USD200 million 7.75% senior unsecured notes due April 2021 to ‘BB-‘ from ‘BB’. The notes were issued by Mei Nian Investment Limited.

The downgrade takes into account Fitch’s expectation that Meinian’s leverage will remain high due to persistent negative free cash flow (FCF) and weak FFO fixed-charge coverage. Revenue increased by 1% in 2019, much slower than the 35% in 2018 and our forecast of 13%, due to a decrease in 4Q20. Although capital intensity in 2019 fell compared to 2018, the weaker profitability caused FFO adjusted net leverage to rise to 4.7x in 2019 from 3.8x in 2018.

We expect Meinian to slow network expansion and focus on consolidating and improving the profitability of existing medical centres in the medium term. Capex related to expansion will decrease as a result, but free cash flow will likely remain negative in the next two years due to investments in other areas, such as upgrading IT systems, and a gradual recovery in profitability.

Key Rating Drivers

Weaker Financial Profile: Fitch expects Meinian’s FFO fixed charge coverage to remain low at around 2x and deleveraging will be unlikely with continued negative FCF. Fitch expects Meinian’s shift away from aggressive expansion and towards higher efficiency to result in a more conservative financial policy. Fitch expects EBITDA to decline in 2020, partly due to the short-term effects from the coronavirus outbreak, but recent changes in strategy add to the uncertainty of cash flow generation. Therefore, FFO adjusted net leverage is likely to remain between 4x and 5x in 2020-2021.

Lower Capex: Fitch expects more conservative network expansion to decrease acquisition-related capex, which should narrow the negative FCF. Fitch-defined capex includes minority investments in new centres and investments to increase its stakes in minority-held centres to majority-held because we believe these are crucial to Meinian’s growth.

The company’s total capex declined to CNY2.2 billion in 2019 from CNY3.0 billion in 2018 due to the decrease in investments for medical centres. We expect the company to continue investing in IT systems and to upgrade medical equipment to enhance service quality and stay competitive. Fitch estimates capex to fall to about CNY1.7 billion a year in 2020 and 2021.

Lower Utilisation Pressures Profitability: Fitch expects the switch to focus on service quality to weigh on utilisation in the short term due to controls on customer numbers and the loss of price-sensitive individual customers. Utilisation is key for profitability as a large proportion of costs, such as rental and staff costs, are fixed. Individual customers contribute to utilisation as they have more flexibility in their appointments than corporate customers, who tend to complete their check-ups towards year end.

We expect Meinian to face challenges in acquiring high-quality individual customers who are willing to pay more for better service as these customers have more choices and may be reluctant to switch providers. Revenue contribution from individual customers decreased to 22% of total revenue in 2019 from 25% in 2018.

Coronavirus Impact: Meinian’s business operation was interrupted significantly by the coronavirus outbreak. The majority of its centres were closed in 1Q20, leading to a decline in revenue of more than 50%. Most of the medical centers resumed normal operations from April 2020. We expect full-year revenue to decrease slightly, assuming a strong recovery in 3Q and 4Q.

Alibaba Plays a Strategic Role: We expect more stringent internal controls to support the company’s sustainable growth after Alibaba Group Holding Limited (A+/Stable) became a strategic investor in November 2019. In addition, cooperation with Alibaba in e-commerce can help Meinian expand its individual-customer base. For example, Meinian can use Alibaba’s online platforms to divert traffic to its medical centres and promote its check-up packages. Alibaba will also cooperate with Meinian on IT system upgrades to streamline the check-up process and provide comprehensive pre and post check-up services.

Market Position Maintained: Despite slower revenue growth, Fitch expects Meinian to maintain its market leadership as the gap with the next player is significant. Meinian has been the country’s largest private medical-examination service provider for the past few years and solidified its market position with the acquisition of Ciming Health Checkup Management Group Co., Ltd. We expect higher demand for medical examinations due to rising health awareness, which supports Meinian’s growth in the long run.

Derivation Summary

Meinian’s market leadership in China’s private health check-up market and stable customer base generally compare favourably against peers and balance its financial profile, which is weak relative to peers rated in the ‘BB’ range. There are no rated peers in this market, but Fitch benchmarks Meinian against retail companies that also use leased operating premises, although we recognise the private health check-up market in China is more stable and has higher growth potential.

Meinian has a stronger business profile than China-based 361 Degrees International Limited (B+/Stable) as Meinian is the leader in its market while 361 Degrees ranks lower in the sportswear market. Although the sportswear market is also likely to grow in China, Fitch thinks the less fragmented health check-up market and a strong base of corporate customers provide Meinian with more stable traffic and growth prospects. Meinian’s stronger business profile justifies a rating above 361 Degrees despite a moderately weak financial profile due to rental expenses forming a big share of costs.

Meinian’s credit profile is more comparable with those of global retail issuers, such as Levi Strauss Co. (Levi, BB/Negative) as rental expenses are a large part of costs. Meinian has a smaller operational scale in terms of EBITDA than Levi and a weaker financial profile with higher adjusted leverage, lower fixed charge coverage and negative free cash flow, which justifies a rating below Levi.

Key Assumptions

Fitch’s Key Assumptions Within Our Rating Case for the Issuer

- Revenue to decrease in 2020, before recovering to a high single-digit growth in 2023

- EBITDA margin of 19%-20% in 2020-2023

- Rental expense to revenue ratio of 10%-11% in 2020-2023

- Capex of CNY1.7billion per year in 2020-2023, including initial minority investments in new medical centres and investments to increase its stake in minority-held centres to majority-held

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to positive rating action/upgrade:

- FFO adjusted net leverage below 4x for a sustained period (2019: 4.7x, 2020 forecast: 5.0x)

- FFO fixed charge coverage above 2.2x for a sustained period (2019: 1.8x, 2020 forecast: 1.8x)

- Free cash flow trending towards neutral

Factors that could, individually or collectively, lead to negative rating action/downgrade:

- FFO adjusted net leverage above 5x for a sustained period

- FFO fixed charge coverage below 1.8x for a sustained period

- Widening negative free cash flow

Best/Worst Case Rating Scenario

International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit here

Liquidity and Debt Structure

Reliance on Refinancing: As of end-March 2020, Meinian’s available cash on hand of CNY3.3 billion plus unused bank facilities of CNY0.3 billion barely covered its short-term debt of CNY3.7billion. The company is reliant on short-term financing with short-term debt accounting for 54% of total debt at end-March 2020. We expect Meinian to be able to roll over its bank loans given seasonality of the business with improved cash flow generation later in the year and strengthened access to capital following Alibaba’s investment. The company plans to raise up to USD300 million through offshore US-dollar bond issuance to repay its existing USD200 million bond due April 2021 and for general working capital purposes.

Summary of Financial Adjustments

Capex includes acquiring minority stakes in new centres and increasing investments in minority-interest centres to hold a controlling interest

Proceeds from private equity placement not intended for debt repayment is treated as restricted cash

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

ESG Considerations

The highest level of ESG credit relevance, if present, is a score of 3. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity(ies), either due to their nature or to the way in which they are being managed by the entity(ies). For more information on Fitch’s ESG Relevance Scores, visit www.fitchratings.com/esg.

Mei Nian Investment Limited

——senior unsecured; Long Term Rating; Downgrade; BB-

Meinian Onehealth Healthcare Holdings Co., Ltd.; Long Term Issuer Default Rating; Downgrade; BB-; RO:Sta

——senior unsecured; Long Term Rating; Downgrade; BB-

Contacts:

Primary Rating Analyst

Crystal Guo, CFA, CPA

Associate Director

+852 2263 9608

Fitch (Hong Kong) Limited

19/F Man Yee Building 60-68 Des Voeux Road Central

Hong Kong

Secondary Rating Analyst

Cathy Chao, CFA

Director

+852 2263 9967

Committee Chairperson

Kalai Pillay,

Managing Director

+65 6796 7221

Media Relations: Alanis Ko, Hong Kong, Tel: +852 2263 9953, Email: alanis.ko@thefitchgroup.com; Wai Lun Wan, Hong Kong, Tel: +852 2263 9935, Email: wailun.wan@thefitchgroup.com.

Additional information is available on www.fitchratings.com

Applicable Criteria

Corporate Rating Criteria (pub. 01 May 2020) (including rating assumption sensitivity)

here

Corporates Notching and Recovery Ratings Criteria (pub. 14 Oct 2019) (including rating assumption sensitivity)

here

Country-Specific Treatment of Recovery Ratings Rating Criteria (pub. 27 Feb 2020)

here

Sector Navigators: Addendum to the Corporate Rating Criteria (pub. 01 May 2020)

here

Applicable Model

Numbers in parentheses accompanying applicable model(s) contain hyperlinks to criteria providing description of model(s).

Corporate Monitoring & Forecasting Model (COMFORT Model), v7.9.0

1-here

Additional Disclosures

Dodd-Frank Rating Information Disclosure Form

here

Solicitation Status

here

Endorsement Status

here

Endorsement Policy

here

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