21.09.2015, 12:52
Fitch Assigns First-Time 'BBB ' Rating to Red Star Macalline
OREANDA-NEWS. Fitch Ratings has assigned China-based home improvement mall operator Red Star Macalline Group Corporation Ltd. (RSM) a Long-Term Foreign-Currency Issuer Default Rating (IDR) of 'BBB+' and a senior unsecured rating of 'BBB+'. The Outlook is Stable.
RSM's ratings are supported by its position as the No.1 home improvement and furnishing mall operator in China, the hybrid business model of owning malls and managing malls it does not own - which enables RSM to expand quickly while keeping capex low - and its strong financial profile supported by its growing recurring income.
The ratings are constrained by the industry-specific risk in the home improvement retail market, such as possible changes in consumer behavior that would reduce the attractiveness of RSM's malls to its tenants, and the fragmentation in the market, which is in its early stage of development compared to that in developed countries.
KEY RATING DRIVERS
Market Leader, Strong Profile: RSM's malls are spread across 120 cities in 27 provinces, accounting for 10.8% share in the chain home improvement retail mall sector and 3.9% of the mall sector in 2014. RSM benefits from strong home refurbishment demand from increasing primary and secondary market home buyers, and more importantly, from existing property owners, who form more than 60% of the total buying demand. Fitch expects RSM to extend its leadership position with its strong pipeline of malls, both owned and managed. It expects to increase the number of malls to 400 by end-2018 (2014: 158), particularly in lower-tier cities, which are not currently well served by home improvement retailers.
Hybrid Business Model: RSM operates a two-pronged business model - it owns malls for rental and operates malls it does not own for management fees. This strategy allowed RSM to quickly expand without taking on additional debt to stretch its balance sheet. Up to 90% of the new malls in the pipeline will be managed with little capital outlay and minimum investment risk.
Stable Recurring Rental Income: The malls that RSM owns have maintained strong rental rates and high occupancy rates of above 90% through the cycle. RSM's investment property portfolio generated stable rental income of CNY3.9bn in 2014 with a rental yield on market value at 6.9% in line with similarly rated investment property companies in China, such as Dalian Wanda Commercial Property Co. Ltd. (BBB+/Stable) and China Resources Land Ltd. (BBB+/Stable). The managed mall operation also generated stable management fees of CNY237m in 2014, bringing total recurring revenue to CNY5bn.
Niche Benefits: RSM has more bargaining power with tenants and is less threatened by internet sales compared with conventional mall operators or retailers. This is because consumers tend to purchase home improvement and furnishing items less frequently and have lower awareness of such items, while some of products are non-standard with big price tags. All of this drives consumers' demand for face-to-face sales and after-sales services. RSM's malls are located in less prime areas than conventional shopping malls or department stores, but they are nonetheless in hubs with convenient access and sufficient population density.
Solid Financial Profile: RSM has sound credit metrics, commensurate with investment property companies rated 'BBB' and above. Its rental assets of USD11bn generated recurring EBITDA of USD500m with stable margin of above 50% in 2014. This margin level is comparable to that for other Chinese investment properties companies. RSM's margins will improve as it adds more managed malls since these are essentially fee income with no additional costs. Fitch estimates its debt/recurring EBITDA will be 3.4x and recurring income EBITDA interest cover at 2.7x at end-2015. Although RSM is adding malls rapidly, Fitch expects its net debt/ recurring EBITDA to remain below 3.5x in the next 24 months and fall to 2.5x by end-2018; and its recurring EBITDA/gross interest to exceed 3.0x in the next 18 months.
Industry-Specific Risk: RSM's operation will be impacted by any negative development in the market for home improvement and furnishings that affects its tenants. For example, changes in consumer behaviour that favour neighbourhood stores may reduce the attractiveness of RSM's malls to its tenants. This industry is also highly fragmented and RSM's market share is only 2.6% of the total retail market in terms of retail turnover in 2014. However, these risks are mitigated by rising urbanisation and growing affluence in China. This has supported demand for quality home furnishings, especially from home upgraders. There is also uncertainty related to the performance of RSM's new stores.
KEY ASSUMPTIONS
Fitch's key assumptions within our rating case for the issuer include:
- Average occupancy for owned and leased malls at 95% throughout the cycle
- Flat rental rate
- Slight improvement of EBITDA margin of owned and leased portfolio
- Capex outlay up to CNY10bn for the next three years
- 30% dividend payout
RATING SENSITIVITIES
Negative: Future developments that may, individually or collectively, lead to negative rating actions include:
- Recurring EBITDA/gross interest sustained below 3.0x
- Net debt /recurring EBITDA sustained above 4.0x
- Any developments that negatively impact RSM's market positioning, including sustained decline in rental rates and occupancy ratios at its malls
Fitch does not expect positive rating action in the next 12-18 months.
RSM's ratings are supported by its position as the No.1 home improvement and furnishing mall operator in China, the hybrid business model of owning malls and managing malls it does not own - which enables RSM to expand quickly while keeping capex low - and its strong financial profile supported by its growing recurring income.
The ratings are constrained by the industry-specific risk in the home improvement retail market, such as possible changes in consumer behavior that would reduce the attractiveness of RSM's malls to its tenants, and the fragmentation in the market, which is in its early stage of development compared to that in developed countries.
KEY RATING DRIVERS
Market Leader, Strong Profile: RSM's malls are spread across 120 cities in 27 provinces, accounting for 10.8% share in the chain home improvement retail mall sector and 3.9% of the mall sector in 2014. RSM benefits from strong home refurbishment demand from increasing primary and secondary market home buyers, and more importantly, from existing property owners, who form more than 60% of the total buying demand. Fitch expects RSM to extend its leadership position with its strong pipeline of malls, both owned and managed. It expects to increase the number of malls to 400 by end-2018 (2014: 158), particularly in lower-tier cities, which are not currently well served by home improvement retailers.
Hybrid Business Model: RSM operates a two-pronged business model - it owns malls for rental and operates malls it does not own for management fees. This strategy allowed RSM to quickly expand without taking on additional debt to stretch its balance sheet. Up to 90% of the new malls in the pipeline will be managed with little capital outlay and minimum investment risk.
Stable Recurring Rental Income: The malls that RSM owns have maintained strong rental rates and high occupancy rates of above 90% through the cycle. RSM's investment property portfolio generated stable rental income of CNY3.9bn in 2014 with a rental yield on market value at 6.9% in line with similarly rated investment property companies in China, such as Dalian Wanda Commercial Property Co. Ltd. (BBB+/Stable) and China Resources Land Ltd. (BBB+/Stable). The managed mall operation also generated stable management fees of CNY237m in 2014, bringing total recurring revenue to CNY5bn.
Niche Benefits: RSM has more bargaining power with tenants and is less threatened by internet sales compared with conventional mall operators or retailers. This is because consumers tend to purchase home improvement and furnishing items less frequently and have lower awareness of such items, while some of products are non-standard with big price tags. All of this drives consumers' demand for face-to-face sales and after-sales services. RSM's malls are located in less prime areas than conventional shopping malls or department stores, but they are nonetheless in hubs with convenient access and sufficient population density.
Solid Financial Profile: RSM has sound credit metrics, commensurate with investment property companies rated 'BBB' and above. Its rental assets of USD11bn generated recurring EBITDA of USD500m with stable margin of above 50% in 2014. This margin level is comparable to that for other Chinese investment properties companies. RSM's margins will improve as it adds more managed malls since these are essentially fee income with no additional costs. Fitch estimates its debt/recurring EBITDA will be 3.4x and recurring income EBITDA interest cover at 2.7x at end-2015. Although RSM is adding malls rapidly, Fitch expects its net debt/ recurring EBITDA to remain below 3.5x in the next 24 months and fall to 2.5x by end-2018; and its recurring EBITDA/gross interest to exceed 3.0x in the next 18 months.
Industry-Specific Risk: RSM's operation will be impacted by any negative development in the market for home improvement and furnishings that affects its tenants. For example, changes in consumer behaviour that favour neighbourhood stores may reduce the attractiveness of RSM's malls to its tenants. This industry is also highly fragmented and RSM's market share is only 2.6% of the total retail market in terms of retail turnover in 2014. However, these risks are mitigated by rising urbanisation and growing affluence in China. This has supported demand for quality home furnishings, especially from home upgraders. There is also uncertainty related to the performance of RSM's new stores.
KEY ASSUMPTIONS
Fitch's key assumptions within our rating case for the issuer include:
- Average occupancy for owned and leased malls at 95% throughout the cycle
- Flat rental rate
- Slight improvement of EBITDA margin of owned and leased portfolio
- Capex outlay up to CNY10bn for the next three years
- 30% dividend payout
RATING SENSITIVITIES
Negative: Future developments that may, individually or collectively, lead to negative rating actions include:
- Recurring EBITDA/gross interest sustained below 3.0x
- Net debt /recurring EBITDA sustained above 4.0x
- Any developments that negatively impact RSM's market positioning, including sustained decline in rental rates and occupancy ratios at its malls
Fitch does not expect positive rating action in the next 12-18 months.
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