OREANDA-NEWS. April 27, 2015. Fitch Ratings has affirmed Want Want China Holdings Limited's (Want Want) Long-Term Issuer Default Rating (IDR) at 'A-'. The Outlook is Stable. Fitch has also affirmed Want Want's foreign-currency senior unsecured rating and the rating on notes issued by wholly owned subsidiary Want Want China Finance Limited at 'A-'.

The affirmation reflects Want Want's continuous net cash position since its IPO in 2008 and its resilient EBITDA margin of 23.5% in 2014 when it faced a significant input cost increase. Want Want continued to be the dominant player in niche packaged food markets in China with strong operational and execution capabilities and prudent financial management.

KEY RATING DRIVERS
Weaker Sales But Margin Intact: Want Want recorded a 1% drop in sales in 2014 - the first decline since its IPO - but its EBITDA margin of 23.5% was only a slight retreat from the 2013 historical high of 25.3%, and was achieved despite a 28% increase in milk powder input costs. The sluggish sales were due to the shift in the date of the Lunar New Year festival in 2014 and 2015, which left fewer days in 2014 for pre-festival sales. There was also weak gift pack sales following China's anti-corruption campaign and intensifying competition in the dairy sector. Fitch expects Want Want to post better sales and margin in 2015 because of the later occurrence of the Lunar New Year this year, adjustments to its sales mix and lower imported milk powder price. Want Want plans to use part of the savings from lower raw material costs in acquiring extra shelf spaces and hiring additional in-store promoters to drive sales.

Negative FCF Unlikely to Persist: Want Want had a USD413m working capital outflow in 2014 because of high inventory and low ending balance for customer prepayments. This reduced net cash from operations to USD296m from USD953m a year ago, and resulted in negative free cash flow (FCF). The high inventory was mainly due to the expensive milk powder supply it acquired in 2014 rather than an increase in stocks of finished products. The situation is unlikely to persist as the company would benefit from lower milk powder input prices in 2015 and there is limited downside to its customer prepayments for gift packs.

Dominant Position, Niche Products: Want Want is one of the most recognised packaged food brands in China. Its key products - rice crackers, flavoured milk and soft candies - dominate their respective niche product markets in China. Its rice crackers, for instance, are traditional snacks eaten during the Lunar New Year and demand surges ahead of the festival.

Management estimates that its market shares for key products range between 30% and 70% of the Chinese market. Fitch notes that these estimates may be different if the product categories are broadened. The agency, however, acknowledges Want Want's dominance, as evidenced by its significant pricing power, and its ability to defend its margins despite increases in raw material prices and labour cost in China. The company has kept EBIT margins well over 15% through the cycle.

Net Cash Position: Want Want has maintained a net cash position since its IPO in 2008. This is a result of a consistent positive FCF since its IPO except in 2014, the company's history of growing organically and its aversion to acquisitions. Want Want's ratings are based on Fitch's view that the company will continue to maintain a net cash position.

Limited Diversification: Want Want has a limited product portfolio compared with global peers rated in the 'A' rating category (those rated 'A-', 'A' and 'A+'), with just three main product categories. Its flavoured milk segment is dominated by a single product, Hot Kid Milk. However, Want Want consistently tries to diversify its portfolio by launching new products; new products accounted for 5% of 2014 total sales. Fitch does not expect any material change to the product concentration factor over the next two to three years.

KEY ASSUMPTIONS
Fitch's key assumptions within our rating case for the issuer include:
- Sales growth slows to a high single-digit to low teens rate compared with a high double-digit rate before 2013
- Stable EBITDA margin around 23%
- Annual capex budget of about USD300m-350m with limited acquisition outlay
- 65% dividend payout ratio

RATING SENSITIVITIES
Negative: Future developments that may, individually or collectively, lead to negative rating action include:

-failure to maintain a net cash position
-organic growth falling below market rate or weakening of distribution networks leading to EBIT margin falling below 15% on a sustained basis (2014: 20.3%)
-increase in working capital, capex or dividend payout ratio leading to failure to maintain positive FCF

Positive: No immediate positive rating pressure given its limited product diversification. Positive rating action may be considered only if Want Want achieves significant diversification of its current product portfolio on a sustainable basis.