OREANDA-NEWS. July 27, 2015. Fitch Ratings has placed Parkson Retail Group Limited's (Parkson) Long-Term Issuer Default Rating (IDR) and senior unsecured rating of 'BB-' on Rating Watch Negative. The 'BB-' rating on its USD500m 4.5% senior notes due 2018 have also been placed on Negative Watch.

The rating action follows the company's announcement on 15 July 2015 that it has agreed to buy 67.7% of Parkson Retail Asia Limited (PRA) from its parent, Parkson Holdings Berhad , for S\\$228m (CNY1.05bn) in cash. The transaction is subject to approval by Parkson's minority shareholders and the agreement of the Securities Industry Council of Singapore (SIC) to waive the mandatory general offer requirement.

The successful completion of the acquisition will result in Parkson breaching the negative rating sensitivities of above 6x for adjusted FFO net leverage (adjusted for lease, payables, and customer deposits) and below 1.3x for fixed charge coverage.

The Rating Watch will be resolved when the acquisition is completed or when it is terminated, whichever comes first. Parkson's rating will be downgraded by one notch if it successfully acquires PRA. If the acquisition is terminated, Fitch will compare key ratios from Parkson's interim or 3Q results to the thresholds defined below to determine the rating on the company upon the resolution of the Rating Watch.

KEY RATING DRIVERS

Acquisition to Weaken Liquidity: Parkson already faces severe operational headwinds. We expect Parkson's FFO fixed charge coverage to decline to 1.1x at end-2015 from 1.4x a year ago, assuming the acquisition is successful. We estimate that Parkson had CNY4.5bn cash at end-June 2015. Excluding CNY2.5bn of payables to concessionaires and customers' deposits, Parkson had only CNY2bn in available cash, of which CNY1bn will be used to acquire PRA. Fitch believes the persistent weakness in department store sales in China and losses in the initial years of operation of new stores will continue to pressure Parkson's profitability over the next two years. We expect Parkson's EBITDA to continue falling in 2015, after declining to CNY729m in 2014 from CNY931m in 2013. Its EBITDA margin contracted by 368bp in 2013-14.

Structural Subordination: Fitch calculates Parkson's leverage without consolidating PRA's financial data as Parkson's access to PRA's cash flow is only through a dividend declared by PRA. PRA as a listed company will manage its treasury independently of Parkson. We have included PRA's cash dividend in our calculation of Parkson's FFO in generating post-acquisition leverage and coverage ratios. We estimate Parkson's payables-adjusted FFO net leverage will increase to 8.5x at end-2015 following the acquisition, from 6.0x at end-2014.

PRA's Operations Deteriorating: PRA's revenue dropped 3.3% to SGD432m and EBITDA fell 4.5% to SGD102m in the financial year ended 30 June 2014 (FY14). Cash in hand declined 15% to SGD151m at FYE14 from a year earlier, while trade payables only slightly decreased 4% to SGD128m during the same period, which together drove up PRA's net debt and leverage. Fitch believes that PRA's performance has been negatively impacted by the implementation of a goods and services tax in Malaysia, the effects of which will continue to be felt in FY16. PRA is a department store operator with 67 stores across Malaysia, Vietnam and Indonesia and Myanmar. PRA has a concessionaire sales business model (80% of total merchandise sales), with mostly leased stores.

KEY ASSUMPTIONS

Fitch's key assumptions within the rating case for Parkson include:
- Sales proceeds to increase in the low single-digit percentages over the next 24 months;
- EBITDA margin to contract 400bp in 2015, and to stabilise thereafter;
- CNY900m capex in 2015 and CNY500m a year after that
- 48% dividend payout ratio

RATING SENSITIVITIES

If the acquisition of PRA is successful, Parkson's ratings will be downgraded by one-notch and Fitch will establish new rating sensitivities following such downgrade.

If the acquisition is terminated, the following rating sensitivities will apply:

Negative: Future developments that may individually or collectively lead to a negative rating action include:
- Adjusted FFO net leverage (adjusted for lease, payables, and customer deposits) sustained above 6x
- Deterioration in fixed charge coverage to below 1.3x.

Positive: Positive rating action is not envisaged as Parkson's ratings are on Negative Watch. However, when the Rating Watch Negative is lifted, the previous Negative Outlook could revert to Stable if Parkson's same-store-sales growth stabilise, while maintaining its credit metrics above thresholds indicated in the negative rating sensitivities.