November 15, 2017 / 6:38 AM / a year ago

Fitch Publishes First-Time 'B' Rating to JuYang; Outlook Stable

(The following statement was released by the rating agency) HONG KONG, November 15 (Fitch) Fitch Ratings has published China-based hotel operator Si Chuan Province JuYang Group Limited a Long-Term Issuer Default Rating (IDR) of 'B' with a Stable Outlook. Fitch has also assigned the company a senior unsecured rating of 'B' with a Recovery Rating of 'RR4'. JuYang's ratings are supported by the company's stable occupancy, high proportion of non-room hotel services and healthy financial profile. The ratings are constrained by JuYang's small business scale, limited geographical diversification and execution risks related to its expanding culture and tourism businesses. KEY RATING DRIVERS Stable Hotel Operations: JuYang benefits from consistent profit contributions from its hotel segment, which generated 59% of 2016 group gross profit, excluding property development. A large portion of business contracts and hotel memberships are likely to have helped the company achieve a high average occupancy rate of 79% or higher in 2014-2016. The hotel business is also complemented by non-room services, including food and beverages, entertainment and conference facilities, which represented approximately 60% of hotel-segment sales. JuYang intends to add three new hotels in 2017-2018, with over 1,000 rooms combined; an increase of 60% compared with end-2016. Small Scale: JuYang's ratings are constrained by its small business scale. The company generated EBITDA of less than USD70 million in 2016, excluding the contribution from property sales. In addition, JuYang's hotel portfolio is geographically concentrated, with five out of seven hotels located in Luzhou city and almost all of its operations, including non-hotel segments, located within Sichuan province at end-2016. Execution Risks from Expansion: JuYang has started operating a new culture and tourism segment in 2017, which will include the operation of movie theatres and the development of the Weiyuan Shiban River tourist area in Sichuan. Fitch sees the expansion as positive, since the new businesses are aligned with China's structural trends of increased domestic travel and experiential retail shopping. Fitch expects JuYang to benefit from a larger scale, more diverse revenue streams and quick deleveraging if the new segment performs well, but execution risks are high due to JuYang's lack of experience in this area. Solid Financial Profile: JuYang generates high profitability, with an EBITDA margin of over 40%, excluding property development, and has a healthy leverage position. Fitch expects negative free cash flow in the next two to three years due to higher expansionary capex, but cash inflow from property sales should be supportive. The company had a book value of approximately CNY1.3 billion of developed properties as of end-2016. Management intends to sell down its inventory over the next few years. DERIVATION SUMMARY JuYang's credit profile is generally weaker than that of global hotel operators, such as Marriott International, Inc. (BBB/Positive) and Wyndham Worldwide Corporation (BBB-/Rating Watch Negative), due to a significantly smaller operating scale, lack of geographical diversification and limited brand awareness. JuYang has a smaller hotel portfolio and operating scale compared with 'B' category NH Hotel Group S.A. (B/Positive), but is supported by a stronger financial profile with better profitability and lower leverage. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: - Three new hotels to be opened in 2017-2018, with the total number of rooms increasing to 2,744 at end-2017 and 2,924 at end-2018, from 1,831 at end-2016 - Hotel average revenue per available room increasing by 31% to CNY277 in 2018 and by mid-single-digits thereafter due to contributions from new five-star hotels with higher average daily rates and stable room rates and occupancy at 75% for existing hotels - Hotel non-room revenue increasing by 23% yoy to CNY476 million in 2018 following the opening of two new hotels, then moderating to single-digit growth thereafter - Revenue contribution from the culture and tourism segment increasing to CNY293 million in 2020, from CNY12 million in 2017, with the company operating 52 movie theatres by 2020 and developing the Weiyuan Shiban River tourist area - Gross margin of 48%-49% in 2017-2018, down from 57% in 2016, due to the ramp-up period for new hotels, improving to 49%-50% in 2019-2020 as the hotel operations mature and from a higher contribution from the culture and tourism segment - Selling, general and administrative expenses at 16% of sales in 2017-2020 from 14% in 2016 - Capex of CNY700 million in 2017-2018 and CNY600 million in 2019-2020 Key Recovery Rating assumptions: - JuYang would be liquidated in a bankruptcy rather than continue as a going-concern - A haircut of 25% for CNY45 million of receivables, 50% for CNY163 million of inventory, 50% for all property, plant and equipment and 30% for other assets, including developed properties totalling CNY1.1 billion - 10% administrative claims applied on the liquidation value - Offshore secured debt of Chinese operating entities moving ahead of offshore unsecured debt in the distribution waterfall - JuYang does not have offshore unsecured debt, but the Recovery Rating is capped at 'RR4', reflecting average recoverability for offshore creditors in China RATING SENSITIVITIES Developments that May, Individually or Collectively, Lead to Positive Rating Action - Hotel segment gross profit margin at 55% or higher for a sustained period (2016: 56%) - Significantly increased operating scale or diversified earning sources - Total adjusted net debt/operating EBITDAR ratio below 1.0x on a sustained basis (2016: 2.4x) - Increased transparency of company disclosure Developments that May, Individually or Collectively, Lead to Negative Rating Action - Decline in revenue per available room for existing hotel portfolio for a sustained period - EBITDA margin, excluding property development, below 30% for a sustained period (2016: 52%) - Failure to generate planned cash flow from property sales - EBITDAR/(gross interest + rent) below 2.0x (2016: 4.9x) - Total adjusted net debt/operating EBITDAR above 3.5x for a sustained period LIQUIDITY Adequate Liquidity: JuYang had CNY566 million in cash, including bank deposits, and over CNY300 million in unutilised banking facilities as of end-2016, which is more than adequate to cover its short-term debt of CNY336 million. Liquidity could see some pressure from negative free cash flow in the next two to three years due to higher capex, but cash inflow from property sales should be supportive. The company had an unencumbered asset pool with a book value of CNY2.3 billion, excluding developed properties, as of end-2016, which can be a source of contingent liquidity. 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 Rebecca Tang Associate Director +852 2263 9933 Committee Chairperson Kalai Pillay Senior Director +65 6796 7221 Summary of Financial Statement Adjustments - EBITDA excludes contribution from the property development segment. We assume selling, general and administrative expenses at 7% of segment sales - Completed properties reported under inventory are reclassified as assets available for sale - Cash inflow from property sales are assumed to be net of 25% tax in forecast years and are classified as net acquisitions and divestitures below free cash flow 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. 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