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Rating Action:

Moody's affirms Lifestyle International Holdings' Baa3 rating on announcement of spin-off; outlook stable

27 Apr 2016

Hong Kong, April 27, 2016 -- Moody's Investors Service has affirmed Lifestyle International Holdings Limited's (Lifestyle) Baa3 issuer rating.

At the same time, Moody's has affirmed the Baa3 senior unsecured debt ratings on the notes issued by LS Finance (2017) Limited, LS Finance (2022) Limited and LS Finance (2025) Limited. These notes are guaranteed by Lifestyle. A full list of the ratings affected can be found at the end of this press release.

The ratings outlook remains stable.

The rating affirmations follow Lifestyle's announcement on 22 April 2016 that it had submitted to the Hong Kong Stock Exchange a proposal to spin-off and separately list Lifestyle China Group, which will be principally engaged in businesses operating in China (Aa3 negative), namely, department stores, supermarkets and restaurants.

Lifestyle will continue to operate the SOGO-branded department stores in Hong Kong (Aa1 negative).

RATINGS RATIONALE

"The spin-off will significantly reduce Lifestyle's capital expenditures, and allow the company to exit a competitive Chinese market, where its margins are half of those in Hong Kong," says Lina Choi, a Moody's Vice President and Senior Credit Officer. "Such a situation offsets the loss of profits and assets without a proportional reduction in debt."

Moody's notes that the spin-off will increase Lifestyle's concentration risk in Hong Kong, where the retail market is in a downturn.

"However, the company's financial flexibility from its sizable cash and financial assets, as well as positive free cash flows from its Hong Kong operations, offer a strong buffer against any negative impact during downcycles," says Choi, who is also the Lead Analyst for Lifestyle.

Moody's points out that while Lifestyle's China business contributed 15% of the company's reported EBITDA and about half of its consolidated assets in 2015, spinning-off the Chinese operations will significantly reduce Lifestyle's investment and capex requirements, as well as its future borrowings.

Maintenance capex for the two Hong Kong stores will amount to around HKD100 million a year compared to the in excess of HKD1 billion a year that Moody's estimates will be needed for 2017 and 2018, if Lifestyle keeps its China business.

Moreover, exiting the Chinese market will improve Lifestyle's profitability. The company reported 11% EBITDA margins for its operations in China in 2015 versus 22% for its Hong Kong business. The low margins in China reflect the challenges of operating in a slowing economy, anti-corruption measures that have crimped spending, and intense competition from online channels.

However, concentration risk—which represents a constraint on Lifestyle's Baa3 rating—will rise after the spin-off, with Lifestyle's flagship Causeway Bay SOGO store accounting for around 90% of the company's total revenue.

Moody's notes that the Hong Kong retail market has been weak, due to soft demand from local consumers and fewer visits by Mainland Chinese tourists, resulting in an 18% year-on-year fall in retail value during the two months between January and February 2016.

Nevertheless, Lifestyle has a strong operating track record in Hong Kong and its cash flow has been resilient through various downcycles. This is a key driver for the company's Baa3 rating.

The established market position of its flagship store in Causeway Bay is difficult to replicate or replace, because the store benefits from: (1) a landmark location in a prime shopping area; (2) an active management of concessionaires and product mixes; (3) low inventory levels; and (4) strong branding and customer loyalty.

Moody's estimates that Lifestyle's adjusted debt/EBITDA will increase to around 5x at end-2016 compared with 4.3x at end-2015, as a result of a weakening Hong Kong retail environment and the spin-off.

Moody's expects that Lifestyle will: (1) pay down the $500 million bond due in January 2017; (2) not embark on any major debt funded acquisitions; (3) not make significant dividend distributions to its shareholders; and (4) continue to maintain a strong liquidity position.

Accordingly, Moody's estimates that Lifestyle's debt leverage will register around 4x at end-2017, which will support its Baa3 rating.

Lifestyle's strong liquidity position is another key driver of its Baa3 rating. At end-2015, it held HKD8.7 billion in cash and HKD5.1 billion in short-term investments. These liquid assets in aggregate represented around 48% of its total assets at end-2015.

Moody's estimates that even after the spin-off—which will reduce its cash levels by around HKD2 billion—the company will have enough cash to manage its HKD3.2 billion in short-term debt.

The stable outlook on Lifestyle's issuer rating reflects Moody's expectation that after the spin-off, the company will maintain its track record of generating strong and sustainable cash flows in Hong Kong, remain prudent in its financial policy, and maintain strong liquidity levels.

An upgrade of the Baa3 rating is unlikely in the near term, given the company's revenue concentration and moderate scale.

Nevertheless, upgrade pressure could emerge in the medium term, if the company: (1) continues to demonstrate good execution capability and grows in scale; and (2) maintains strong liquidity and a track record of stable cash flow.

Credit metrics indicating upgrade pressure include an adjusted debt/EBITDA below 2.5x-3.0x and EBITDA/gross sales proceeds exceeding 25% on a sustained basis.

On the other hand, downward pressure would arise if:

(1) The company's liquidity position, profitability or cash flow from its Hong Kong stores deteriorate, such that adjusted EBITDA/gross sales proceeds falls below 20%, adjusted debt/EBITDA exceeds 4.5x-5.0x, or adjusted retained cash flow (RCF)/net debt—including 50% of short-term financial assets—falls below 25%-30%;

(2) Lifestyle pursues aggressive distributions to shareholders or investment strategies; or

(3) In the event that the Lifestyle China spin-off does not materialize, Lifestyle's revenue contributions from China are weaker than Moody's expects, or the company adopts a more aggressive debt-funded expansion plan in China.

The principal methodology used in these ratings was Retail Industry published in October 2015. Please see the Ratings Methodologies page on www.moodys.com for a copy of this methodology.

Listed on the Hong Kong Stock Exchange in 2004, Lifestyle International Holdings Limited is a Hong Kong-based retail operator that focuses on mid- to upper-end department stores, through its two retailer brand names, SOGO and Jiuguang. At end-2015, the company operated two SOGO stores in Hong Kong and three Jiuguang stores in China.

List of affected ratings:

Affirmations:

..Issuer: Lifestyle International Holdings Limited

Issuer Rating, Affirmed at Baa3

..Issuer: LS Finance (2017) Limited

$500 million bonds guaranteed by Lifestyle

..Issuer: LS Finance (2022) Limited

$300 million bonds guaranteed by Lifestyle

..Issuer: LS Finance (2025) Limited

$300 million bonds guaranteed by Lifestyle

Outlook Actions:

..Issuer: Lifestyle International Holdings Limited

Outlook, Maintained at Stable

..Issuer: LS Finance (2017) Limited

Outlook, Maintained at Stable

..Issuer: LS Finance (2022) Limited

Outlook, Maintained at Stable

..Issuer: LS Finance (2025) Limited

Outlook, Maintained at Stable

REGULATORY DISCLOSURES

For ratings issued on a program, series or category/class of debt, this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series or category/class of debt or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

The first name below is the lead rating analyst for this Credit Rating and the last name below is the person primarily responsible for approving this Credit Rating.

Lina Choi
VP - Senior Credit Officer
Corporate Finance Group
Moody's Investors Service Hong Kong Ltd.
24/F One Pacific Place
88 Queensway
Hong Kong
China (Hong Kong S.A.R.)
JOURNALISTS: (852) 3758 -1350
SUBSCRIBERS: (852) 3551-3077

Gary Lau
MD - Corporate Finance
Corporate Finance Group
JOURNALISTS: (852) 3758 -1350
SUBSCRIBERS: (852) 3551-3077

Releasing Office:
Moody's Investors Service Hong Kong Ltd.
24/F One Pacific Place
88 Queensway
Hong Kong
China (Hong Kong S.A.R.)
JOURNALISTS: (852) 3758 -1350
SUBSCRIBERS: (852) 3551-3077

Moody's affirms Lifestyle International Holdings' Baa3 rating on announcement of spin-off; outlook stable
No Related Data.
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