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Rating Action:

Moody's downgrades HC Group to B3; outlook stable

 The document has been translated in other languages

03 Sep 2018

Hong Kong, September 03, 2018 -- Moody's Investors Service has downgraded to B3 from B2 the corporate family rating of HC Group Inc. (HC).

The rating outlook is stable.

RATINGS RATIONALE

"The downgrade reflects our concern that the fast growth in HC's principal-model transaction business will heighten risk and reduce profit margins, which is a significant departure from our earlier expectations," says Lina Choi, a Moody's Vice President and Senior Credit Officer.

Prompted by fast development in online sourcing activities, HC's principal-model transaction services segment grew rapidly to 81% of total revenue in the six months ended 30 June 2018 from 38% for the same period last year.

This segment mainly includes its business-to-business (B2B) online sourcing platform and the financing services provided to merchants. HC continues to operate an agency-model for its information marketing business, which now comprises less than 20% of total revenue.

In a principal-model, the operator of the platform takes on inventory from suppliers and sells to its customers. Revenue from this segment primarily represents merchandise sales, and is recognized when the buyers pay fully for the merchandise. In an agency model, the operator of the platform simply matches suppliers and buyers and does not take on inventory risks.

In the first half of 2018, the transaction services segment mainly relied on three sub-platforms focusing on chemical products, cotton, and construction material -- all exposed to commodity-related counterparty risks. Such a high reliance on commodity-related industries adds volatility to HC's cash flow generation ability, especially during industry down cycles.

"The company's much decreased level of profitability, weakened EBITDA generation, and increased leverage have also reduced the company's financial buffer for weathering potential market volatility," adds Choi.

HC reported an EBITDA margin of 6.3% for the six months to 30 June 2018 compared to 19.5% in same period last year. The significant decline in the EBITDA margin was driven by the change in HC's business strategy to develop lower-margin transaction services.

Total EBITDA, after adjusting for one-off fair-value gains, decreased by around 9% to about RMB238 million in the first half of 2018. This growth rate is much lower than our earlier expectations, which had assumed a higher EBITDA contribution from the agency-model information marketing business.

Moody's expects that HC will continue to grow its principal-model transaction services business to expand its business scale. The company believes it can raise profitability at a larger scale of operation through improved bargaining power against merchants.

While high revenue growth will continue off a low base, HC's adjusted EBITDA margin will be much lower around 6%-8% in the next 12-18 months, driven by the fast growth of the lower-margin transaction business. This compares with our earlier expectations of adjusted EBITDA margins around 15%.

With lower margins and slower EBITDA growth, HC's adjusted debt/EBITDA was around 3.7x for the 12 months to June 30 2018, and Moody's expects it will rise to the 4.0x-4.2x range in the next 12-18 months. Moody's expects that the company's debt level will increase moderately to fund the fast growth of its transaction services business, while its EBITDA growth will flatten.

As the company is transitioning its business to a lower-margin principal model relying primarily on commodity-related industries, we believe that the related heightened business risks position the company more appropriately at the B3 rating level.

HC's B3 rating continues to reflect its established position in China's business-to-business eCommerce market and steady revenue from its core platforms, including "hc360.com" and "zol.com.cn". Its integrated full service model increases the stickiness of its subscribers. The model also helps HC gather upstream and downstream demand and supply information, and raise monetization potential.

At the same time, the rating also reflects HC's modest size relative to its industry peers, reduced financial buffer as demonstrated by weakened profitability and increased leverage, high working capital requirements, and uncertainty relating to its business model transition.

HC's liquidity is weak. As of 30 June 2018, its cash and cash equivalents of RMB402 million was insufficient to cover its short-term debt of RMB895 million.

The stable rating outlook reflects Moody's expectation that HC will: (1) maintain its market position as a leading B2B service provider in China; (2) continue to grow its revenue scale and generate stable cash flows; and (3) demonstrate prudent financial management and to maintain its access to funding.

Upward ratings pressure could arise if HC: (1) demonstrates sustainable revenue and EBITDA growth from its principal-model-driven transaction business; (2) contains its exposure to the financial, reputation and execution risks related to the finance business; (3) deleverages and improves its debt maturity profile; and (4) starts to generate positive free cash flow on a consistent basis.

Credit metrics indicating a potential rating upgrade include the following on a sustained basis: EBITDA margins above 10%-12%, and adjusted debt/EBITDA — including debt from its finance unit — below 3.0x-3.5x.

On the other hand, Moody's will likely downgrade the company's ratings if HC:

(1) Fails to maintain a steady EBITDA trend, due to a substantial decline in its core business and market share, which could affect its cash flow generation;

(2) Experiences significant financial impairment or capital calls from its finance business;

(3) Engages in aggressive acquisitions that pressure its balance sheet liquidity or raise its overall risk profile; or

(4) Shows a deterioration in its profit margin and weakened access to funding, due to increased competition or poor working capital management.

Metrics that would point to a downgrade include the following on a sustained basis: EBITDA margins decrease to below 5%, or adjusted debt/EBITDA — including debt from its finance unit — trends toward 5.0x, and the company shows negative cash flow from operations, all on a consistent basis.

The principal methodology used in this rating was Business and Consumer Service Industry published in October 2016. Please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.

Established in 1992 and listed on the Hong Kong Stock Exchange in 2003, HC Group Inc. is one of the leading B2B eCommerce operators in China. HC provides one-stop integrated B2B business solutions and a supply and demand platform for SMEs.

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.

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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
Client Service: 852 3551 3077

Gary Lau
MD - Corporate Finance
Corporate Finance Group
JOURNALISTS: 852 3758 1350
Client Service: 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
Client Service: 852 3551 3077

No Related Data.
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