Fitch Downgrades Red Star Macalline to 'BB' from 'BB+'; Outlook Negative
(The following statement was released by the rating agency)
Fitch Ratings-Hong Kong/Shanghai-17 March 2021:Fitch Ratings has downgraded China-based Red Star Macalline Group Corporation Ltd.'s (RSM) Long-Term Foreign-Currency Issuer Default Rating (IDR), senior unsecured rating and rating of the USD300 million senior notes due 2022 to 'BB' from 'BB+'. The Outlook on the IDR is Negative.
The downgrade reflects Fitch's estimate that RSM's recurring EBITDAR/gross interest + rent dropped to around 1.5x at end-2020, worse than our previous forecast of 1.7x. RSM had a larger drop in recurring revenue, and capex was higher than our expectation. Fitch expects coverage of above 1.5x in 2021-2022, if RSM slows capex and financial investment cash outflow. Fitch also thinks that RSM's opportunistic liquidity management is no longer commensurate with a 'BB+' rating even if recent liquidity has been adequate.
The Negative Outlook reflects the risk that the recovery in RSM's credit metrics may be slower than we expect. In addition, the parent Red Star Macalline Holding Group Company Limited's (RSH) liquidity is tight, and the uncertainty over RSH's refinancing and deleveraging plans in the next 18 months may affect RSM's funding access. Fitch may also reassess the linkage if the impact is stronger than our expectation.
Key Rating Drivers
Lower Interest Coverage: Fitch estimates RSM's recurring EBITDAR interest coverage dropped to around 1.5x by end-2020, from 1.7x at end-2019. Fitch estimates that RSM's recurring revenue (self-owned/leased mall rentals + fixed franchise fee from managed malls) dropped by around 15% to CNY7 billion in 2020, because of rental waivers granted to tenants after the Covid-19 outbreak (one month to all self-owned and leased malls; more than one month to malls located in severely affected regions), a larger-than-expected drop in occupancy rates and mall closures.
Fitch does not expect interest coverage to quickly return to pre-outbreak levels. We expect cash interest in 2021-2022 to be higher than before due to higher gross debt and a higher effective interest rate. In addition, RSM's recurring EBITDA margins have fluctuated in recent years and we believe they may remain under pressure as new malls ramp up.
Lower Occupancy Rate: Fitch expects RSM's occupancy rate to partially recover in 2021, although there may be some lingering impact from Covid-19 and new mall openings will slow the recovery. RSM's occupancy rate for self-owned and leased malls recovered to 92% by end-2020 from 90% at end-1H20 (2019: 93%). The occupancy rate has been dropping since end-2017 when it was 98%, due mainly to new mall openings at less central areas than RSM's mature mall portfolio. RSM says it is focused on streamlining mall operations from 2021 and aims to bring occupancy back to 95%.
High Leverage at RSM: RSM's capex and large financial investments in the past few years have caused leverage to rise. Fitch estimates RSM's leverage - measured by adjusted net debt/recurring EBITDAR - to be around 10x at end-2020 from 8x at end-2019, and come down to 9x in the medium term, driven mainly by a reduction in capex. According to RSM, net cash outflows from investments (capex less asset disposals) will drop to CNY2 billion in 2021 from above CNY5 billion in 2020. Fitch has treated 40% of around CNY2.5 billion listed company investment as cash in the leverage calculation.
Parent May Affect RSM: RSH's refinancing uncertainties may affect RSM's funding access, despite the weak parent-subsidiary ties, as the two companies' bond prices have experienced similar volatilities in a weak market environment. RSM's rating is constrained to two notches above RSH's consolidated profile, which we assess as 'b+'.
Fitch estimates that RSH's leverage, measured by net debt/adjusted inventory (including guarantees), was 65% at end-2020, versus 56% at end-2019. Leverage is higher than some 'B+' rated issuers in the sector, but it is mitigated by strong recurring EBITDA coverage - Fitch estimates that RSH's consolidated recurring EBITDA/cash interest was 0.7x at end-2020. RSH has been committed to deleveraging since 2H20 via asset sales and it plans to list some subsidiaries in 2021 as well. RSH generated CNY40 billion of attributable contracted sales in 2020 mainly from Tier 3-4 cities in eastern China.
Weak Parent-Subsidiary Linkage: Fitch assesses the RSM-RSH linkage as 'Weak', reflecting 'Weak' legal ties and 'Weak' operational ties, under Path A - Strong Subsidiary, Weak Parent, in accordance with our Parent and Subsidiary Linkage Rating Criteria. RSH and RSM have separate treasury management and minimal operational overlap. RSH appoints only three of the 14 directors of RSM's board, which also has four non-executive members from minority shareholders including two from Alibaba Group Holding Limited (A+/Stable).
However, Fitch may reassess the linkage if RSH has more impact on RSM's funding access than we expect. RSH held 70% of RSM at end-2020, but that may fall as low as 56% if RSM raises a maximum CNY3.7 billion from an A share placement.
ESG Governance - Management Strategy: RSM has an ESG Relevance Score of '4' for management strategy due to opportunistic liquidity management. RSM's management strategy has a negative impact on its credit profile, and is relevant to the rating in conjunction with other factors. Fitch believes a clearer and longer record of consistently improving liquidity by management would help in removing the rating constraint.
Derivation Summary
RSM is China's largest owner and operator of malls specialising in home improvement and furnishing products, with 15-16% market share and CNY91 billion in investment properties as of end-September 2020.
RSM's rating is constrained by weakening financial profile and its opportunistic liquidity management. Fitch estimates RSM's recurring interest coverage ratio was around 1.5x at end-2020, and forecasts a gradual recovery in the ratio to above 1.5x by end-2021-2022E - a level commensurate with 'BB' credits - if management lowers capex.
RSM has larger assets, EBITDA scale and asset diversification than Nan Fung International Holdings Limited (BBB-/Stable). However, the quality of its assets is weaker as RSM's malls specialise in home improvement and furnishing products with limited product diversification, while Nan Fung's assets are in Hong Kong's prime shopping district and attract stronger institutional interest. Nan Fung's recurring EBITDA/gross interest of 1.9x-2.0x at end-2020 was stronger than that of RSM.
RSM's business and financial profile is stronger than that of Lai Fung Holdings Limited (B+/Stable). RSM's scale is much larger than Lai Fung and the portfolio is more diverse. Lai Fung's non-development EBITDA interest coverage was below 1.0x.
RSM's ratings are also capped at two notches above the consolidated credit profile of its parent, RSH, which we assess at 'b+'.
Key Assumptions
Fitch's Key Assumptions Within Our Rating Case for the Issuer:
- Portfolio mall revenue of CNY6.6 billion, CNY7.9 billion and CNY8.4 billion in 2020E-2022E, respectively;
- Annual franchise fee of CNY4 million-4.2 million in 2020E-2022E;
- Recurring EBITDA of CNY3.7 billion-4.4 billion in 2020E-2022E;
- Capex and acquisitions reduced to CNY2 billion from 2021E;
- No asset disposals in 2021-2022E;
- 5.8% funding cost for new borrowings;
- Readily available cash balance CNY4 billion-5 billion in 2020E-2021E.
RATING SENSITIVITIES
Factors that could, individually or collectively, lead to negative rating action/downgrade:
- Adjusted net debt/recurring EBITDAR above 11.5x for a sustained period;
- Recurring EBITDAR/gross interest plus rent expenses below 1.5x for a sustained period;
- Weakening of RSH's consolidated credit profile, including the ratio of consolidated net debt to adjusted inventory sustained above 65%, or deterioration of RSH's liquidity.
Factors that could, individually or collectively, lead to positive rating action/downgrade:
- The Outlook may be revised to Stable if the negative guidelines are not met in the next 18 months.
Best/Worst Case Rating Scenario
International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.
Liquidity and Debt Structure
Opportunistic Liquidity Management: RSM has been keeping a fairly low cash level compared to its short-term debt since 2019. Fitch estimates that RSM's available cash/short-term debt ratio dropped to 0.2x at end-September 2020 from 0.5x at end-2019. RSM had readily available cash of CNY4 billion as of end-September 2020, excluding net proceeds collected on behalf of tenants, against short-term debt of more than CNY16 billion. However, we estimate that CNY1.5 billion and CNY2.5 billion were wealth management products and liquid listed companies' shares, respectively. These can be divested to provide liquidity, if necessary. Fitch thinks that RSM's liquidity management is opportunistic and may put pressure on the rating. Still, RSM had adequate liquidity as of end-2020, in Fitch's view.
RSM's Refinancing Plan in Place: RSM detailed a plan with investors on March 2 to refinance its CNY3.5 billion bond maturities in June-July 2021. Management estimated CNY2.5 billion cash flow from operations (before CNY1.2 billion interest payment, in Fitch's estimate) and CNY2 billion proceeds from potential non-core asset disposals in 1H21. RSM had CNY10.6 billion unpledged investment properties (with ownership certificates) as of end-2020, according to management. In addition, RSM obtained a CNY1.1 billion ABS issuance quota in February 2021.
Fitch estimates that bank loans accounted for 60% of RSM's total debt of CNY46 billion as of end-2020. These borrowings are secured mainly by RSM's investment properties and can easily be rolled over.
RSH's Tight Liquidity: RSH's (excluding RSM) liquidity was tight with CNY12.7 billion of cash and CNY19.6 billion of short-term debt at end-2020, according to RSH. Fitch estimates that more than 80% of RSH's outstanding debt is non-bank loans or bonds that are harder to extend than bank loans. RSH has prepared sufficient funds to refinance its CNY5.5 billion bonds due in March-April 2021 while Fitch thinks there is some uncertainty regarding CNY8.9 billion of capital market instruments due in 2022.
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING The principal sources of information used in the analysis are described in the Applicable Criteria.
ESG Considerations
RSM has an ESG Relevance score of '4' for Management Strategy due to opportunistic liquidity management. This has a negative impact on its credit profile, and is relevant to the rating in conjunction with other factors.
Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg
Red Star Macalline Group Corporation Ltd.; Long Term Issuer Default Rating; Downgrade; BB; Rating Outlook Negative
----senior unsecured; Long Term Rating; Downgrade; BB
Hong Kong Red Star Macalline Universal Home Furnishings Limited
----senior unsecured; Long Term Rating; Downgrade; BB
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Corporate Monitoring & Forecasting Model (COMFORT Model), v7.9.0 (1)
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