Fitch Downgrades Hengdeli to 'B+'; Outlook Stable; Off Rating Watch

Hengdeli Holdings

22/03/2016 08:30

(The following statement was released by the rating agency)

SHANGHAI/HONG KONG/SINGAPORE, March 22 (Fitch) Fitch Ratings has downgraded 
Hengdeli Holdings Limited's (Hengdeli) Long-Term Foreign-Currency Issuer Default 
Rating and senior unsecured rating to 'B+' from 'BB'. The Recovery Rating is 
RR4. The Outlook on the IDR is Stable. The ratings have been removed from Rating 
Watch Negative.

The downgrade reflects Hengdeli's higher business risk that led to continued 
financial deterioration in 2015. The Hong Kong and China market for luxury 
watches slowed down drastically in 2H15, and there is little sign of imminent 
recovery. Hengdeli's EBITDA margin narrowed further - to 6.2% from 7.5% in 2014; 
and FFO-adjusted net leverage increased to 4.4x from 3.4x as a result. Fitch 
expects Hengdeli's margins and leverage to remain flattish over the next 12 
months. 

KEY RATING DRIVERS

Faster Decline in Sales: Hengdeli's sales shrank in all its markets in 2015. The 
decline in same-store sales growth (SSSG) widened to 9.5% for the China market 
from 4.5% in 1H15 and 2.7% in 2H14, due to a drastic slowdown in mid-end watch 
sales in 2H15. Sales in Hong Kong (excluding Harvest Max, a souvenir and watch 
retailer acquired in 2013) plunged by 27% as tourist arrivals fell. The overall 
stagnation in luxury watch spending may persist in the medium term due to the 
economic slowdown, weakening real disposable income and middle-class spending 
shift.

Continued Margin Pressure: Fitch expects the pressure on profitability to 
persist in 2016 due to the weak consumer spending, sales discounting and 
flattish distribution cost. Hengdeli's EBITDA margin contracted by 130bp to 6.2% 
in 2015 (2014: 7.5%), resulting in a 26% EBITDA decline. Fitch expects a 
mid-single-digit EBITDA margin in 2016 and 2017. 

Rising Leverage: The reduced EBITDA and slower inventory turnover (252 days in 
2015 versus 224 days in 2014) resulted in a higher FFO-adjusted net leverage of 
4.4x (3.4x at end-2014). Fitch expects leverage to remain high in 2016, pending 
the pace of inventory reduction with practicable sales discounts, as well as the 
extent of profit margin erosion. 

Modest Operational Flexibility: Hengdeli has taken proactive measures to adapt 
to the changing market. These steps include a significant store closure plan, 
product mix optimisation and lease-contract renewal at lower rates. Hengdeli 
closed net 31 stores (16 stores in China, seven in Hong Kong/Macau and eight in 
Taiwan) in 2015, and shows a willingness to continue to close underperforming 
stores in 2016. 

Adequate Liquidity. Hengdeli maintained sufficient cash of CNY1.9bn to cover its 
current borrowings of CNY704m as of end-2015. Besides, the company has 
sufficient bank facilities to bridge working-capital purposes. Fitch expects 
Hengdeli to generate positive cash flow even at the current low profitability as 
capex has been cut back significantly. 

Leader Position Remains. Hengdeli has maintained the leading position in Swiss 
watch retailing in China, with a dominant market share of over 35%. In addition, 
Hengdeli's wholesale business segment also remained stable due to its 
established exclusive distribution arrangements with brand owners. Fitch expects 
Hengdeli to keep its overall leading market position over the next two years. 

KEY ASSUMPTIONS

Fitch's key assumptions within our rating case for the issuer include:

- Low- to mid-single-digit revenue decline in 2016-2017

- EBITDA margin hovers around 5.3%-6.7% in 2016-2019

- Annual capex plus acquisition budget of about CNY150m

RATING SENSITIVITIES

Positive: Developments that may, individually or collectively, lead to positive 
rating action include:

- Sales stabilisation or re-acceleration in China and Hong Kong

- EBITDA margin sustained above 8%

- FFO-adjusted net leverage sustained below 3.0x

Negative: Developments that may, individually or collectively, lead to negative 
rating action include:

- Persistent and material sales contraction in China and Hong Kong

- EBITDA margin sustained below 5%

- FFO-adjusted net leverage sustained above 4.0x

Contact: 

Primary Analyst

Yee Man Chin

Director

+852 2263 9696

Fitch (Hong Kong) Limited

19/F, Man Yee Building

68 Des Voeux Road, Hong Kong

Secondary Analyst

Yi Zhang

Analyst

+86 21 5097 3390

Committee Chairperson

Kalai Pillay

Senior Director

+65 6796 7221

Media Relations: Leslie Tan, Singapore, Tel: +65 67 96 7234, Email: 
leslie.tan@fitchratings.com; Wai-Lun Wan, Hong Kong, Tel: +852 2263 9935, Email: 
wailun.wan@fitchratings.com.

Additional information is available on www.fitchratings.com.

Applicable Criteria 

Corporate Rating Methodology - Including Short-Term Ratings and Parent and 
Subsidiary Linkage (pub. 17 Aug 2015)

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