OREANDA-NEWS. Fitch Ratings has downgraded China-based department store operator Golden Eagle Retail Group Limited's (Golden Eagle) Long-Term Issuer Default Rating (IDR) and senior unsecured rating to 'BB+' from 'BBB-'. The Outlook is revised to Stable from Negative.

The downgrade reflects deterioration of Golden Eagle's operating environment and the longer investment payback period on stores opened in past few years, which have resulted in weaker credit metrics that have already been under pressure from continued capex and acquisitions.

The Stable Outlook reflects Golden Eagle's sufficient liquidity, with its operating cash flow and its CNY5.4bn available cash able to meet its committed capex.

KEY RATING DRIVERS

Weaker Cash Generation: Golden Eagle saw CNY500m working capital outflow in 2014 because the ending balance of prepaid shopping cards fell as it sold fewer cards during the year. This reduced net cash from operations to CNY1.1bn from CNY1.7bn a year ago. Before 2013, the company enjoyed higher negative working capital each year as its business expanded. Fitch expects Golden Eagle's cash generation to continue to be weak because it continues to face pressure from declining prepaid shopping cards sales. Slowing sales and the need to hold more inventory for direct sales will also require more working capital in the next two to three years.

Longer Payback Period for New Stores: Golden Eagle's earnings are also under pressure because new stores are taking longer to start generating profits because of competition from other department stores and other retail formats like shopping malls, specialty stores and e-commerce retailers. At end-2014, eight of its 27 stores that have been open for more than two years were unprofitable at the EBIT level. At end -2013, only four stores in operation for over two years out of a total of 26 stores were unprofitable.

Higher Leverage to Persist: The difficult operating environment has resulted in Golden Eagle's payables adjusted net leverage increasing to 3.27x in 2014 from 2.3x in 2013. Fitch estimates that Golden Eagle's payables adjusted net leverage ratio will remain above 3.0x in the next 24 months as the company still has quite an aggressive new store pipeline. In addition, the company has continued investing in merchandising and marketing to cope with weak retail sentiment and structural changes in the industry. These initiatives, however, will only improve earnings meaningfully over the longer term.

Challenging Retail Market: Golden Eagle's same-store sales fell 5.5% in 2014 compared with growth of 2.9% a year ago. The company has taken steps, including launching private and exclusive labels and adding more lifestyle elements to its stores, to stem the slide, but the success of these efforts also depend on improvement in consumer sentiment. The challenge is compounded by the lack of differentiation among department stores and changing shopping behaviour among consumers.

Adequate Liquidity: The company's unrestricted cash and cash equivalents remained robust at CNY5.4bn at end-2014, sufficient to cover its short-term debt of CNY3.1bn and near-term capex requirements. Golden Eagle's annual capex budget of around CNY1.5bn for store expansion in 2015-17 is flexible because it is going to acquire some stores from its parent and will be able to get favourable terms, such as timing of the acquisitions and mode of payment.

KEY ASSUMPTIONS
Fitch's key assumptions within our rating case for the issuer include:
- Neutral to low single-digit same-store sales growth in China
- EBITDA margin to slightly weaken but sustain above 40%
- Customer prepayment to fall 8% in 2015 but stabilise after that
- Annual capex budget of about CNY1.5bn with limited acquisition outlay
- 30% dividend payout

RATING SENSITIVITIES

Negative: Future developments that may, individually or collectively, lead to negative rating action include
- Adjusted FFO net leverage (adjusted for lease, payables, and customer deposits) being sustained above 3.75x
- EBITDA margin being sustained below 40%
- Sustained negative free cash flow

Positive: Future developments that may, individually or collectively, lead to positive rating action include
- Recovery of the business environment such that it sustains growth in same-store sales
- Proven ability to reach EBIT breakeven for new stores within three years of operation
- Sustained positive free cash flow
- Adjusted FFO net leverage (adjusted for lease, payables, and customer deposits) being sustained above 3x