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Rating Action:

Moody's downgrades Reward to B2; outlook negative

 The document has been translated in other languages

17 Jul 2017

Hong Kong, July 17, 2017 -- Moody's Investors Service has downgraded to B2 from B1 the corporate family rating (CFR) of Reward Science and Technology Industry Group Co., Ltd., (Reward) as well as the rating on the 7.25% 3-year backed senior unsecured notes issued by Reward International Investment Limited and guaranteed by Reward.

The ratings outlook remains negative.

RATINGS RATIONALE

"The downgrade reflects our expectation that the company's leverage will remain high, given the volatility in its operating performance and its dependence on the dairy segment for operating cash flows," says Gloria Tsuen, a Moody's Vice President and Senior Analyst.

"The downgrade also reflects the low transparency in the company's financial disclosure, which is an area for improvement," adds Tsuen.

The previous B1 CFR was based on the expectation that the company would deleverage to below 4.5x by the end of 2017.

However, the significant volatility in its revenue and margins -- partly a result of the company's relatively small size and limited market shares -- will make it challenging for Reward to achieve that level of leverage. Moody's estimates Reward's leverage will be in the 5.5x-6.0x range in the next 6-12 months, which is more commensurate with a B2 rating.

In addition, the delay in the disclosure of the spin-off of part of its daily consumer products business reflects low transparency. This is negative for the company's ratings.

Based on the first public financial statement filing by its standalone daily consumer products segment, Beijing Luowa Daily Chemicals Limited (unrated), Reward's operating cash flow comes from a narrower base than Moody's previous expectations. Luowa Daily Chemicals' reported operating cash flow totaled only 4% of Reward's consolidated reported operating cash flow in 2016. This means that over 95% of Reward's operating cash flow depended on the company's remaining businesses, mainly its dairy segment which is more exposed to commodity price cycles and regulatory risks than Luowa Daily's cleaning products.

Reward is in the process of listing Luowa Daily Chemicals on China's National Equities Exchange and Quotations.

In 2015, Reward spun off a portion of its daily consumer products business that it did not deem material, but only disclosed this spin-off in June 2017. Considering that the transaction involved related parties, the recent disclosure shows that there is meaningful room for improvement in the transparency and timeliness of the company's communication with investors.

Moody's expects Reward's liquidity will remain adequate. Its reported cash balance of RMB6.6 billion at end-March 2017 is more than enough to cover its RMB1.9 billion in short-term debt and bills payable.

Reward's B2 CFR is supported by its: (1) vertically integrated dairy supply chain, which helps to ensure product safety; (2) growing cleaning products business; and (3) solid liquidity.

At the same time, the rating is constrained by the company's: (1) small size and limited market shares; (2) new entry into the highly competitive and highly regulated infant milk formula market; (3) execution risks related to its growth-driven business plan, including cross-border acquisitions (which Reward is new to); and (4) high ownership concentration.

The negative outlook reflects the high volatility in Reward's operating performance, its reliance on the dairy segment for operating cash flows, high debt leverage, and the low transparency in its disclosure.

There is no upward ratings pressure, given the negative outlook. However, the outlook could return to stable if Reward: (1) reduces the volatility in its operating performance, and (2) reduces adjusted debt/EBITDA to below 5.5x in the next 12 months.

Downward rating pressure could emerge if: (1) Reward's operational performance or liquidity weakens; (2) the company fails to reduce leverage; or (3) it fails to maintain sound corporate governance.

Credit metrics indicative of downgrade pressure include an adjusted EBIT margin below 8% or adjusted debt/EBITDA above 6.0x on a sustained basis.

The principal methodology used in these ratings was Global Packaged Goods published in January 2017. Please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.

Headquartered in Beijing, Reward Science and Technology Industry Group Co., Ltd. engages in the production and marketing of dairy and other food products, as well as daily consumer products (mainly cleaning products), and other businesses, such as the leasing of commercial property and hotels.

It generated RMB7.6 billion in revenue in 2016, with 60% derived from dairy and other food products, 29% from daily consumer products, and 11% from other businesses.

Reward is a private company 96%-owned by its founder and chairman, Mr. Hu Keqin, and his family.

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.

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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.

Gloria Tsuen, CFA
Vice President - Senior Analyst
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

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