OREANDA-NEWS. Fitch Ratings has assigned China-based Hangzhou Hikvision Digital Technology Co., Ltd. (Hikvision) Long-Term Foreign-Currency and Local-Currency Issuer Default Ratings (IDRs) of 'A-' with Stable Outlook. The agency has simultaneously assigned a senior unsecured rating of 'A-' and an expected 'A-(EXP)' rating to the company's proposed senior unsecured euro notes.

The final rating on the notes is contingent upon the receipt of final documents conforming to information already received. The notes are rated in line with Hikvision's senior unsecured rating of 'A-' as they will represent direct, unconditional, unsecured and unsubordinated obligations of the company. The proceeds from the proposed senior unsecured notes will be used to refinance Hikvision's existing debt and for capex, procurement of raw materials and general corporate purposes.

KEY RATING DRIVERS

CETC's Only Surveillance Platform: Hikvision's ratings benefit from a one-notch uplift due to its moderately strong linkage with China Electronics Technology Group Corporation (CETC). Hikvision, whose standalone rating level is 'BBB+', is CETC's only platform in the surveillance market within the CETC group and the general platform for CETC's key projects such as "Safe City" and "Smart City". It is CETC's most profitable subsidiary, contributing a significant portion of CETC's EBIT and cash flow from operations (CFO) in 2014. CETC is wholly owned by the State-owned Assets and Administration Commission of the State Council.

Steady and Solid Industry Growth: Fitch expects China's video surveillance market to expand further, driven by the continued increase in China's public security expenditure, corporates' spending on security and surveillance, and the acceleration in the upgrade cycle to Internet Protocol (IP)-based surveillance systems. Being the market leader, Hikvision should remain the prime beneficiary of the industry growth. The video surveillance market is a large, stable market that continued to grow during the global financial crisis in 2008. China is the world's largest video surveillance market, accounting for one-third of global demand.

Leading Market Positions: The ratings reflect Hikvision's world-leading market positions in closed-circuit television (CCTV) and video surveillance equipment. According to Frost & Sullivan, Hikvision tops every CCTV/surveillance equipment category by revenue and Hikvision's global market share expanded to 9.0% in 2014, from 4.3% in 2012. In China, which is Hikvision's main market (around 75% of revenue), the company held a market share of 19.9% in 2014, up from 13.4% in 2012. For higher-end markets, such as government and large enterprises, Hikvision's market share is over 30%.

Fragmented Market Structure: The ratings also reflect Fitch's view that the global video surveillance market is likely to remain fragmented in the next three years. However, Fitch expects to see increasing industry consolidation in China, driven by stiff price competition at the lower-end of the market and the increasing need for economies of scale in R&D and distribution.

Strong R&D Ability: Hikvision possesses strong R&D ability and cost benefits, which are reinforced by the company's large scale. Video surveillance products and solutions have become increasingly R&D intensive. Hikvision has the largest R&D team in the industry and spends significantly more on R&D than competitors on video surveillance technologies and products. This significant lead in R&D could translate into a much broader product portfolio and more customised features, enabling the company to maintain market-leading positions.

Cost Leadership: Hikvision's low cost base enables it to have a larger engineering team than its competitors, which should assist in the development of broader product portfolios and respond quicker to changing markets. In addition, as the largest hardware supplier in the global video surveillance market, Hikvision has strong bargaining power with upstream component suppliers and downstream system integrators/contractors and distributors.

High Profitability; Solid Cash Generation: Hikvision has the highest profitability among its global and domestic rivals, due to its economies of scale and integrated business model with broad product range. It also benefits from a stronger market position in the government and large enterprise segments, which require more customisation. Fitch expects Hikvision's margins to trend down in the next three years mainly due to an increase in price competition in the lower-end segments. However, we expect Hikvision's operating margin to remain relatively high, at 20% or above, in the next three years, which in turn should support solid CFO generation.

KEY ASSUMPTIONS

Fitch's key assumptions within the rating case for Hikvision include:
- robust industry growth in China and steady market share gains are likely to continue to drive over 20% compound annual growth rate (CAGR) for 2015-2017
- profit margins under some pressure partly due to competition and partly due to a change in sales mix with higher sales in the lower-end segments
- capex to increase significantly, compared to previous years, in 2015-2018 due to construction of the Tonglu production facility and the internet R&D centre
- dividend payout ratio at 30%-35%

RATING SENSITIVITIES

Negative: Future developments that may, individually or collectively, lead to negative rating action include:
- any sign of weakening linkage with CETC
- significant deterioration in its market position in the video surveillance market
- significant M&A that negatively affects the operations or the business profile
- sustained operating EBIT margin of 20% or below (2014: 30%)
- sustained funds flow from operations (FFO)-adjusted leverage above 1.0x (2014: 0.1x)
- loss of net cash position

Positive: Future developments that may, individually or collectively, lead to positive rating action include:
- any sign of strengthening linkage with CETC
- meaningful increase in video surveillance market share whilst maintaining credit metrics at their current level, or better.

LIQUIDITY

Low Leverage; Strong Liquidity: Hikvision has a conservative capital structure and solid liquidity. It had a net cash position of CNY4.4bn at end-September 2015. Fitch expects the company to maintain a conservative capital structure with a large net cash position over the medium to long-term, as we believe the company will continue to maintain high profitability and gain market share in the steadily expanding video surveillance market.

FULL LIST OF RATING ACTIONS

Long-Term Foreign Currency IDR assigned at 'A-'; Outlook Stable
Long-Term Local Currency IDR assigned at 'A-'; Outlook Stable
Foreign-currency senior unsecured class rating assigned at 'A-'
Expected rating on proposed euro notes assigned at 'A-(EXP)'