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Rating Action:

Moody's revises Zhongsheng's outlook to positive on potential acquisition; ratings affirmed

 The document has been translated in other languages

02 Jul 2021

Hong Kong, July 02, 2021 -- Moody's Investors Service has affirmed Zhongsheng Group Holdings Limited's Baa3 issuer rating and senior unsecured rating.

At the same time, Moody's has revised the outlook to positive from stable.

"The outlook change to positive reflects our expectation that Zhongsheng's potential acquisition of Jardine Matheson Holdings Limited's (JMH) Mercedes-Benz auto dealer network in China could enhance Zhongsheng's business profile as a leading Mercedes-Benz dealer with higher market share, increase its strategic importance as JMH's sole auto dealer platform in China and solidify its strategic partnership with Daimler AG (A3 stable)," says Roy Zhang, a Moody's Vice President and Senior Analyst.

"The rating action also reflects our expectation that Zhongsheng will continue to grow its operating scale and reduce its reliance on short-term debt. We also expect the company to increase its liquidity buffer as a result of its strong free cash flow generation, while maintaining prudent financial management with leverage, as measured by adjusted debt/EBITDA, improving to around 2.0x. This leverage level is strong for its rating category," adds Zhang.

Zhongsheng announced on 1 July 2021 that it plans to acquire JMH's (A1 stable) 100% owned Mercedes-Benz auto dealer network in China with a preliminary and indicative total amount of US$1.3 billion (RMB8.7 billion), comprised of US$900 million (RMB6.0 billion) in cash and US$400 million (RMB2.7 billion) in new Zhongsheng shares to be subscribed by JMH.

After the transaction closure, JMH's equity interest in the company could increase to 21.3% from 19.6% as of the end of 2020.

RATINGS RATIONALE

Zhongsheng's Baa3 issuer rating reflects the company's leading market position, large dealership network, favorable brand and market exposure, flexible business model and efficient operational management. The rating also considers the company's solid financial metrics, prudent financial and strategic partnership with its minority shareholder, JMH.

The rating is constrained by Zhongsheng's reliance on short-term financing and high capital needs for expansion both organically or through acquisition, which are in line with the industry norm. The risks are partially tempered by Zhongsheng's strong business profile, good funding access and sustained free cash flow generation.

This acquisition would increase Zhongsheng's important role as the only Mercedes-Benz dealer in China for JMH with its equity interest in Zhongsheng increasing to 21.3% from 19.6% as of the end of 2020. The acquisition target, The Zung Fu China Group, is a leading Mercedes-Benz dealer in Greater China owned by JMH, with very high market shares in Southern and Western China.

As the market continues to recover, Moody's expects Zhongsheng's revenue to grow about 23% in 2021 even without the potential transaction. Zhongsheng's revenue increased 19.6% in 2020 in spite of the pandemic impact, with the bulk of the gross profits arising from recurring maintenance services and luxury brands. The strong performance is supported by the company's favorable brand exposure.

This transaction can enhance its market position in luxury brand offerings, which have a solid demand outlook and provide better returns to dealers. Zhongsheng is also strategically important to several established automakers including Mercedes-Benz, and has contributed a significant portion of its revenue.

Zhongsheng managed to reduce its reliance on short term debt through bond issuances. The company issued US$450 million bond due 2026 in the first quarter of 2021. The new funding channel helps the company to access long-term financing at a reasonable cost.

Moody's estimates that the potential acquisition will have limited impact on Zhongsheng's solid credit profile. Zung Fu China has performed strongly, maintained a solid credit profile and reported a net cash position. As of the end of 2020, it reported revenue and profit before tax of about 12% and 11%, respectively, of Zhongsheng's.

Moody's forecasts Zhongsheng's leverage will stay around 2.0x over the coming 12 to 18 months even after factoring in potentially higher debt due to the acquisition and a larger operating scale. The company's strong free cash flow generation and prudent financial management help to control leverage at that level. Zhongsheng's leverage has declined to 2.1x as of end the 2020 from 2.6x as of the end of 2019.

Zhongsheng's liquidity is adequate. Its cash on hand and operating cash flow are sufficient to meet its financial obligations within the next 12-18 months with its strong free cash flow generation and reduced reliance on short-term debt. However, similar to other companies in the auto dealer industry, Zhongsheng faces high working capital requirements and will need to undertake short-term financing to fund them.

Zhongsheng has demonstrated its funding capacity and intention to balance long-term and short-term funding arrangements. This was seen in its recent USD bond issuance and track record of established banking relationships and multiple funding channels, including bank loans, syndicated loans both onshore and offshore, equity, convertible bonds, and automaker financing.

The issuer rating on Zhongsheng is not affected by subordination to claims at the operating company level. This is because, despite its status as a holding company with a majority of claims at the operating subsidiaries, Zhongsheng's creditors benefit from the group's highly diversified business profile — with cash flow generation across a large number of operating subsidiaries — which mitigates structural subordination risk.

The rating also takes into account the following environmental, social and governance (ESG) considerations.

Zhongsheng faces similar social and environmental risks related to the larger automotive ecosystem, due to consumer demand, global supply chain challenges, transportation of inventory, and the use and protection of consumer data.

In terms of governance risk, the founders, Mr Yi Huang and Mr Guo Qiang Li, together own about 58% of the company's shares. This risk is mitigated by the presence of a material minority shareholder, JMH, with two board members from JMH as well as Zhongsheng's good track record of prudent financial management since its listing in 2010. Zhongsheng and JMH have a collaborative relationship.

FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGS

Moody's could upgrade Zhongsheng's ratings if the company enhances its market position and maintains its solid financial profile as it grows. At the same time, its liquidity profile improves on a sustained basis, such that its unrestricted cash and free cash-flow generation can cover its short-term debt obligations.

Credit metrics that could indicate such a scenario include: (1) leverage, as measured by adjusted debt/EBITDA, remaining below 2.5x, and (2) EBIT/interest sustaining above 6x.

The outlook could return to stable if (1) Zhongsheng's business profile fails to improve; (2) liquidity deteriorates; (3) financial policy turns more aggressive; or (4) financial profile weakens on a sustained basis such that its leverage is not likely to be maintained below 2.5x, or EBIT/interest could fall below 6x.

A reduction of JMH's equity interest in Zhongsheng is negative to the latter's ratings.

The principal methodology used in these ratings was Retail Industry published in May 2018 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1120379. Alternatively, please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.

Zhongsheng Group Holdings Limited is a leading auto dealer in China. It operated 373 stores across 24 provinces in China as of the end of 2020. Headquartered in Dalian, Zhongsheng was founded by Mr Yi Huang and Mr Guo Qiang Li, who are the controlling shareholders of the company. Jardine Matheson Holdings Limited is a strategic investor, owning about 20% of the company as of the end of 2020. Zhongsheng was listed on the Hong Kong Stock Exchange in March 2010.

REGULATORY DISCLOSURES

For further specification of Moody's key rating assumptions and sensitivity analysis, see the sections Methodology Assumptions and Sensitivity to Assumptions in the disclosure form. Moody's Rating Symbols and Definitions can be found at: https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_79004.

For ratings issued on a program, series, category/class of debt or security this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series, category/class of debt, security 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.

The ratings have been disclosed to the rated entity or its designated agent(s) and issued with no amendment resulting from that disclosure.

These ratings are solicited. Please refer to Moody's Policy for Designating and Assigning Unsolicited Credit Ratings available on its website www.moodys.com.

Moody's considers a rated entity or its agent(s) to be participating when it maintains an overall relationship with Moody's. Unless noted in the Regulatory Disclosures as a Non-Participating Entity, the rated entity is participating and the rated entity or its agent(s) generally provides Moody's with information for the purposes of its ratings process. Please refer to www.moodys.com for the Regulatory Disclosures for each credit rating action under the ratings tab on the issuer/entity page and for details of Moody's Policy for Designating Non-Participating Rated Entities.

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

Moody's general principles for assessing environmental, social and governance (ESG) risks in our credit analysis can be found at http://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1288435.

The Global Scale Credit Rating on this Credit Rating Announcement was issued by one of Moody's affiliates outside the EU and is endorsed by Moody's Deutschland GmbH, An der Welle 5, Frankfurt am Main 60322, Germany, in accordance with Art.4 paragraph 3 of the Regulation (EC) No 1060/2009 on Credit Rating Agencies. Further information on the EU endorsement status and on the Moody's office that issued the credit rating is available on www.moodys.com.

The Global Scale Credit Rating on this Credit Rating Announcement was issued by one of Moody's affiliates outside the UK and is endorsed by Moody's Investors Service Limited, One Canada Square, Canary Wharf, London E14 5FA under the law applicable to credit rating agencies in the UK. Further information on the UK endorsement status and on the Moody's office that issued the credit rating is available on www.moodys.com.

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.

Roy Zhang
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

Clement Cheuk Yiu Wong
Associate Managing Director
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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