(The following statement was released by the rating agency)
Nov 28 -
Summary analysis -- Parkson Retail Group Ltd. --------------------- 28-Nov-2012
CREDIT RATING: BB+/Stable/-- Country: China
Primary SIC: Department stores
Mult. CUSIP6: 70147B
Credit Rating History:
Local currency Foreign currency
21-Apr-2011 BB+/-- BB+/--
07-Nov-2006 BB/-- BB/--
The rating on Parkson Retail Group Ltd. reflects: (1) the fragmented and competitive nature of China’s retail market; (2) the dependence of Parkson’s product mix on discretionary spending, which is sensitive to economic cycles; (3) the challenging operating conditions in which the company operates; and (4) Parkson’s affiliation with Lion Group (not rated), which has a weaker credit profile. The company’s favorable concessionaire business model, improving geographic diversification, disciplined balance sheet management, and the good long-term growth prospects of the Chinese retail sector temper these risks. We assess Parkson’s business risk profile as “satisfactory” and its financial risk profile as “significant.”
We expect a downturn in demand to impact Parkson more than other department store operators in China. This is because the company focuses on the mid- to high-end retail segment. Parkson’s same-store sales fell in the third quarter of 2012, the first such instance in the past six years, due to fierce competition and a weak economy. We expect same-store sales to remain sluggish in the coming 12 months.
However, Parkson has also toned down its expansion plan and demonstrated good financial discipline. The company opened only three new stores in the first nine months of 2012, compared with the 12 new stores it had planned. It closed two stores in July, taking the total numbers of stores it operates and manages to 53 stores in 35 cities, compared with 52 stores in 34 cities at the end of 2011.
We expect Parkson’s credit protection metrics to weaken slightly in 2012 due to: (1) a slowdown in China’s economy; (2) the company’s continued high level of operating-lease-adjusted debt, given that most of the retail space is under long-term leases; and (3) its likely low cash flows from new stores in the initial years. Parkson’s ratio of operating-lease-adjusted debt to EBITDA weakened to 4.3x as of Sept. 30, 2012, on a rolling 12 months basis, from 3.8x as of Dec. 31, 2011. We applied the company’s operating lease figure at the end of 2011 in our calculation. Our base-case scenario estimates the ratio at 4.0x-4.5x in 2012-2013.
Parkson’s business risk is low mainly because of its concessionaire sales model. The contribution of concessionaire sales to total revenue increased to 90.3% for the first nine months of 2012, from 86.9% in 2006. The balance came from direct sales. Working capital requirement for concessionaire sales is low given that Parkson bears limited inventory risks for such sales and receives all gross revenues upfront. We do not expect the company to significantly change its business model.
Parkson’s balance sheet remains strong. We expect the company to manage its growth with discipline and readjust its expansion plan according to market conditions. Parkson holds a large amount of cash because of its cash generative concessionaire business. Such holdings give the company the option to purchase stores rather than lease them, and therefore reduce debt. The cash holdings therefore mitigate the risk of the company’s growing operating-lease-adjusted debt leverage. We note that Chinese retailers often have greater flexibility to terminate their operating leases than their peers in many other countries.
In our opinion, the Chinese retail market has strong growth potential for the next few years despite some temporary setbacks. The Chinese government has shown strong commitment to promoting domestic consumption, rather than relying on exports and fixed-asset investments as it did in the past. Total retail sales in China rose 17.1% year on year in 2011, significantly higher than the economic growth of 9.2%. Overall retail sales grew 14.1% for the first 10 months in 2012, also higher than the Chinese government’s GDP growth estimate of 7.5% for 2012. We expect China’s retail growth to continue to outpace GDP growth in the next few years.
Parkson’s liquidity is “strong,” as defined in our criteria. We expect the company’s sources of liquidity, including cash and facility availability, to exceed its uses by 1.5x or more over the next 12 months and remain above 1.0x over the next 24 months. Sources of liquidity will exceed uses even if EBITDA declines by more than 30%. Our liquidity assessment incorporates the following factors and assumptions:
-- Parkson’s sources of liquidity primarily include cash and short-term investments of about Chinese renminbi (RMB) 4.5 billion, as of Sept. 30, 2012.
-- Uses of liquidity include a syndicated loan of US$400 million (about RMB2.5 billion) due in 2013. The company has no other borrowings.
-- Parkson’s cash in hand and cash flow from operations are sufficient to meet committed capital expenditure, working capital needs, debt repayments, and dividend payouts over the next 12 months.
-- The company has sufficient headroom in its loan covenant to absorb a 30% decline in EBITDA.
Parkson has a net cash position since 2005, excluding operating-lease-adjusted debt. We expect the company to continue to adhere to its liquidity policy of maintaining a minimum cash balance equal to its trade payables. Nevertheless, we view Parkson’s dividend payout policy of about 44%-48% as high compared with the 14.57% average payout ratio for listed Chinese retailers. However, Parkson’s payout is in line with that of other listed department store operators.
Due to Parkson’s cash-generative concessionaire business model, we expect the company to fund most of its expansion through cash holdings and cash flow from operations.
The stable outlook reflects our expectation that Parkson will pursue growth by leveraging on its concessionaire model while maintaining its “strong” liquidity and disciplined financial management.
We may lower the rating if Parkson’s financial performance deteriorates because of a severe economic downturn in China, intensified competition, the company’s more aggressive expansion plan than we expected, or any negative impact from the company’s association with its parent, the Lion Group. Downgrade triggers could be the ratio of operating-lease-adjusted total debt to EBITDA at more than 4.5x on a sustained basis, or a deterioration in the company’s liquidity to less than “strong.”
We are unlikely to raise the rating in the next 12 months because we expect the operating conditions of the Chinese retail sector to remain tough and due to Parkson’s association with the Lion Group. However, we could upgrade Parkson if the company executes its accelerated growth strategy such that it becomes a market leader and maintains discipline in financial management. Upgrade triggers could be the ratio of operating-lease-adjusted total debt to EBITDA of 3.0x-3.5x on a sustainable basis.
Related Criteria And Research
-- Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012
-- Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011
-- Key Credit Factors: Business And Financial Risks In The Retail Industry, Sept. 18, 2008
-- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008
-- 2008 Corporate Criteria: Ratios And Adjustments, April 15, 2008