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Rating Action:

Moody's downgrades Hengdeli to Ba3; outlook negative

 The document has been translated in other languages

01 Apr 2016

Hong Kong, April 01, 2016 -- Moody's Investors Service has downgraded to Ba3 from Ba2 Hengdeli Holdings Limited's corporate family rating and senior unsecured bond rating.

The rating action concludes Moody's review for downgrade initiated on 19 February 2016.

The ratings outlook is negative.

RATINGS RATIONALE

"The downgrade of Hengdeli's ratings reflects our concerns over a rapid deterioration in the high-end retail watch market in China and Hong Kong, which has in turn lowered the company's revenues and weakened its credit metrics," says Lina Choi, a Moody's Vice President and Senior Credit Officer.

Hengdeli reported a 9.9% year-on-year decline in its 2015 revenue to RMB13.3 billion.

Moody's notes that the revenue decline accelerated in 2H 2015 to 13.3% from 6.2% in 1H 2015, indicating further deterioration on a sequential basis.

Hengdeli's Hong Kong business demonstrated the highest year-on-year revenue decline of 27%, while its China business recorded a 7% revenue decline from 2014.

Its Hong Kong operations were more reliant on revenues from the sales of high-end watches.

In Moody's view, the revenue decline could be more severe if the company had not increased its discount commission.

Despite this strategy, the company's inventory level was high, as reflected by the inventory days-on-hand, which rose to 248 days in 2015 from 227 days in 2014.

Moody's also notes that the company's selling, general and administrative expenses as a percentage of total revenues went up to an all-time-high of 24.9% in 2015 as the company's gross revenues declined.

Its adjusted EBITDA margin (after adjusting for one-off items) also fell to 12.1% in 2015 from 13.0 % in 2014 due to revenue weakness and increased commission costs.

In view of the slowing economy in China, Moody's does not anticipate meaningful improvements in Hengdeli's revenue or profitability.

Though the company has proactively diversified its product mix in favor of mid-end products, sales of discretionary-type products will face formidable challenges amid subdued consumer sentiment.

Therefore, the company's revenue will remain weak and uncertain for the next 12--18 months.

Moody's estimates that the company will suffer a revenue decline of 5%-10%. And its adjusted EBITDA margin will fall to around 10%.

The company's credit metrics -- measured by adjusted debt/EBITDA and retained cash flow/net debt -- will be 5x-5.5x and 15%-18%, respectively. Such levels position the company in the lower Ba rating level.

On the other hand the company's liquidity position remains strong. Its cash to short term debt ratio was high at 2.7x as of end-2015.

In addition, the company's business has been cash generative and it reported annual positive operating cash flow. Moody's estimates Hengdeli's operating cash flow to be around RMB500 million in 2016.

Hengdeli's Ba3 corporate family rating reflects the company's leading position in China's fast-growing market for luxury and fine watches, supported by its large retail and distribution network.

The rating is also supported by the execution of the company's strategy to shift its product mix towards mid-end watches from high-end products, as well as an increased focus on customers in Tier 2 to Tier 4 cities.

In addition, the rating takes into account the company's solid track record of achieving growth, its good liquidity profile, and its close relationships with key suppliers, including Swatch Group and LVMH. Both companies are also strategic shareholders.

On the other hand, the rating is constrained by Hengdeli's exposure to the economic cycles associated with luxury and fine watches.

Because of the weaker demand for luxury and fine watches in an economic downturn, Hengdeli's strategy of offering discounts on certain products has led to a decline in its profitability.

The negative outlook reflects Moody's expectation that Hengdeli's revenue, profitability and credit metrics will continue to be under pressure in the next 12-18 months, when economic growth in China will likely remain slow.

Given the negative ratings outlook, upgrade ratings pressure is unlikely. However, the ratings outlook could return to stable, if Hengdeli can (1) arrest the fall in revenue and profitability; and (2) improve its credit metrics such that its adjusted debt to EBITDA ratio is below 4.5x--5.0x and adjusted retained cash flow to net debt in excess of 15%-18% on a sustained basis.

However, Hengdeli's ratings will be under downgrade pressure if its revenue, profitability and cash flow continue to decline, such that its (1) adjusted debt/EBITDA is in excess of 5.0x-5.5x, or (2) retained cash flow/net debt trends below 12 %-15%, all on a sustained basis.

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.

Hengdeli Holdings Limited listed on the Hong Kong Stock Exchange in 2005 and its market capitalization was HKD5.3 billion as of 2 September 2015. As of end-2014, the Zhang family was the largest shareholder, with a 31.96% stake, followed by Swatch Group (unrated) (9.12%) and LVMH Group (unrated) (6.37%).

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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 downgrades Hengdeli to Ba3; outlook negative
No Related Data.
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