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Sector Review: China's Small Consumer And Tech Companies Rely On Refinancing To Survive


Sector Review: China's Small Consumer And Tech Companies Rely On Refinancing To Survive

China's small consumer and technology companies will continue to battle liquidity issues for the rest of this year. An S&P Global Ratings analysis of 31 entities points to an increased reliance on short-term debt and deteriorating cash buffers that will strain their ability to meet obligations. We estimate the group has over US$30 billion-equivalent in debt coming due over the next 12 months.

Trade tensions between China and the U.S. have undermined consumer sentiment and could disrupt supply chains. Intensifying competition and volatile raw material costs will continue to weigh on the profits and cash flows in the industry, in our view.

The rating outlook on 39% of this group of companies is skewed towards the downside. We have taken rating actions across the spectrum since 2018, mainly reflecting weakening liquidity or deteriorating capital structures. About 80% of our rating actions over the past 12-18 months were negative. Diminished liquidity buffers or the buildup of short-term debt accounted for 70% of these negative actions.

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Scope Of Our Analysis

For this report, we analyzed 31 companies with public or confidential speculative-grade ratings ('BB+' or below) that were mainly engaged in the asset-light, consumption-driven sectors in China, including consumer products and services, retail, healthcare, leisure, entertainment, telecom, technology, and transportation. We excluded state-owned enterprises from our analysis as the credit ratings on these issuers typically assume government support in a distress scenario.

Rising debt maturity and dwindling access to long-term funding weakens capital structures

Small consumer and technology companies in our rated universe face a maturity wall in 2019 and 2020. Maturing bullet debt (including puttable bonds) will increase 15%-20% to Chinese renminbi (RMB) 65 billion (US$9.4 billion) in 2019, from RMB56 billion in 2018. While most rated issuers will likely refinance upcoming maturities or extend puttable bonds by one or two years, we expect the increase in financing costs to be substantial.

Rising debt costs will strain companies with already-low interest coverage ratios and compel some to accept shorter debt maturities. Those issuers needing to bolster liquidity may seek expensive alternative funding or sell assets.

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Equity would appear to be a funding option for many--94% of the rated issuers in this report are listed or have listed subsidiaries. But heavy use of share pledges in borrowings can limit a company's capacity to use equity to pay down debt.

Issuers or substantial shareholders of issuers with more than 60% of shares pledged against loans have a strong incentive to keep the share price strong, discouraging equity issuance. Moreover, while Chinese stock prices rebounded at the start of 2019, continued trade friction between the U.S. and China contributed to an equities sell-off in May, denting the attractiveness of share sales.

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The group's debt capital is also skewing towards shorter tenors, even as debt balances remained largely the same in 2018 versus 2017. Companies with a weighted average debt maturity of below two years jumped to about 50% at the end of 2018, from below 20% in 2017. Difficulties in obtaining new financing, and a substantial increase in financing costs when liquidity in the markets tightened in 2018, largely explain this shortening of debt maturities.

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In the fourth quarter of 2018, the government rolled out measures to increase lending to privately owned enterprises (POEs). Such measures could incentivize banks to roll over debt for smaller POEs. These could ease liquidity risks for groups with good banking relationships and substantial bank loans. Nevertheless, access to long-term bank facilities remain limited for companies with asset-light business models, which describes most of the issuers in the technology and consumer sectors. Such companies often do not have substantial assets to use as collateral for longer-term loans.

Many companies also face declining profitability and diminishing cash flows

The cash conversion cycle will likely lengthen amid a tightening of liquidity among suppliers and customers along the supply chain. Compared with 2018, we anticipate a further deterioration of major liquidity sources (cash on hand and free operating cash flow) of small consumer and technology companies in our rated universe.

Trade tensions between China and the U.S. continue to threaten supply chains. The direct impact on operations should be manageable, given these companies' focus on domestic consumption; however, second-order effects--such as poor sentiment and market volatility--could hamper cash flows over the next 12-24 months.

The appetite for capital investment remains strong, despite a likely erosion of cash flows. While this is probably due to the companies' need to upgrade technology, innovate products or expand scale, such measures could also signal difficulties in curtailing expenditure when liquidity is tight.

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Amid increasing short-term debt and decreasing free cash flows, the ratio of cash and free operating cash flow as a percentage of short-term debt liabilities is likely to decrease to about 83% in 2019 from about 120%. In addition, short-term bullet debt--including puttable bonds--will represent 37% of major liquidity sources, up from 26% in 2018.

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Rating outlook is increasingly negative due to liquidity risks

Small consumer and technology companies will contend with ratings pressure over the next 12 months. As of May 2019, 39% of this group of companies had a negative rating outlook, from 13% in 2018, pointing to the potential for rating downgrades. In addition, over half of these companies have weak or less-than-adequate liquidity, which is nearly double the levels in mid-2018.

Although liquidity conditions have improved in the onshore credit market in China from the trough in the fourth quarter of 2018, uncertainties remain whether small consumer and technology companies will benefit evenly from a market recovery. To survive the liquidity crunch, we believe these companies will need to use banking relationships, pare ambitions for capital investment, and carefully plan refinancings.

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Related Research

  • Dr. Peng Telecom & Media Group Downgraded To 'B-' On Rising Liquidity Strain And Refinancing Risks; Outlook Negative, May 22, 2019
  • Shandong Ruyi Technology Outlook Revised To Negative On Uncertain Deleveraging Plan; 'B' Rating Affirmed, May 15, 2019
  • Rating On Maoye International Raised To 'B'; Outlook Stable, May 10, 2019
  • CAR Inc. 'BB-' Rating Affirmed With Negative Outlook; Refinancing Plan Announced, April 23, 2019
  • Yihua Enterprise (Group) Co. Ltd. Downgraded To 'B-' On Weakening Liquidity And Capital Structure; Outlook Negative, April 17, 2019
  • Shandong Sanxing Group Downgraded To 'B+' On Rising Reliance On Short-Term Debt; Outlook Stable, March 26, 2019
  • 361 Degrees Downgraded To 'BB-' On Weakening Market Position And Cash Flow; Outlook Negative, March 19, 2019
  • GOME Retail Holdings Downgraded To 'B+' On Delayed Turnaround; Outlook Negative; Issue Rating Lowered To 'B', March 8, 2019
  • eHi Car Services Outlook Revised To Negative On Reducing Liquidity Buffer Amid Fleet Expansion; 'BB-' Rating Affirmed, Feb. 20, 2019
  • Tunghsu Group Co. Ltd. Downgraded To 'B-' On Ongoing Liquidity Pressure; Outlook Negative, Feb. 18, 2019
  • Xinjiang Guanghui Industry Investment (Group) Co. Ltd. 'B' Rating Affirmed With Stable Outlook; Off Watch Developing, Feb. 1, 2019
  • YanAn Bicon Pharmaceutical Upgraded To 'CCC+' On Refinancing Of Bonds; Outlook Negative; Off CreditWatch Developing, Jan. 23, 2019

Appendix

Table 1

Issuers To Watch–-Key Liquidity Concerns For Issuers Within The Scope Of The Report
Company name Rating/Outlook What to watch

Shandong Ruyi Technology Group Co. Ltd.

B/Negative Elevated debt leverage and narrowing liquidity buffer if the company can't improve its operating cash flow or scale back capital investment

361 Degrees International Ltd.

BB-/Negative Deteriorating market position and operating cash flow amid intense competition and weak working capital management

Yihua Enterprise (Group) Co. Ltd.

B-/Negative Weakening capital market access and the execution risk in cash collection from real estate project firms

GOME Retail Holdings Ltd.

B+/Negative Execution and effectiveness of the company's turnaround strategy to restore growth and profitability

YanAn Bicon Pharmaceutical Listed Co.

CCC+/Negative Unsustainable capital structure owing to its sizable short-term-debt maturities and additional capital investment needs for Shanyang project

CAR Inc.

BB-/Negative Uncertainties around market demand and the impact on its pending refinancing plan

Pactera Technology International Ltd.

CCC+/Negative Refinancing short-term maturities and identify new funding alternatives

Dr. Peng Telecom & Media Group Co. Ltd.

B-/Negative Significant debt maturities in mid-2020, but limited progress in refinancing

Tunghsu Group Co. Ltd.

B-/Negative Persistent liquidity pressure owing to its high refinancing needs amid tight funding conditions in China

eHi Car Services Ltd.

BB-/Negative Reducing liquidity buffer and tight covenant headroom amid fleet expansion
Source: S&P Global Ratings.

Table 2

Publicly Rated Issuers Included In This Report
Company name Sector Rating/Outlook Liquidity Capital structure Business risk profile Financial risk profile

Yihua Enterprise (Group) Co. Ltd.

Consumer B-/Negative Weak Negative Weak Highly leveraged

Shandong Sanxing Group Co. Ltd.

Consumer B+/Stable Less than adequate Negative Weak Aggressive
Health & Happiness (H&H) International Holdings Ltd. Consumer BB+/Stable Adequate Neutral Fair Intermediate

Maoye International Holdings Ltd.

Retail B/Stable Less than adequate Neutral Fair Highly leveraged

Xinjiang Guanghui Industry Investment (Group) Co. Ltd.

Retail B/Stable Less than adequate Negative Satisfactory Aggressive

Golden Eagle Retail Group Ltd.

Retail BB/Stable Adequate Neutral Fair Significant

GOME Retail Holdings Ltd.

Retail B+/Negative Adequate Neutral Fair Highly leveraged

Parkson Retail Group Ltd.

Retail B-/Stable Adequate Neutral Weak Highly leveraged

361 Degrees International Ltd.

Apparel BB-/Negative Strong Neutral Weak Significant

Shandong Ruyi Technology Group Co. Ltd.

Apparel B/Negative Less than adequate Neutral Fair Highly leveraged

Melco Resorts (Macau) Ltd.

Gaming BB/Stable Strong Neutral Fair Significant

Studio City Co. Ltd.

Gaming BB-/Stable Adequate Neutral Weak Highly leveraged
YanAn Bicon Pharmaceutical Ltd. Co. Healthcare CCC+/Negative Weak Negative Weak Highly leveraged

CAR Inc.

Leasing BB-/Negative Less than adequate Neutral Fair Intermediate

eHi Car Services Ltd.

Leasing BB-/Negative Adequate Neutral Weak Significant

Pactera Technology International Ltd.

IT Services CCC+/Negative Weak Neutral Weak Highly leveraged
Dr. Peng Telecom & Media Group Co. Ltd. Telecom B-/Negative Weak Negative Weak Highly leveraged

Beijing Kunlun Tech Co. Ltd.

Internet BB-/Stable Adequate Neutral Weak Significant
Tunghsu Group Co. Ltd. Tech Hardware B-/Negative Less than adequate Neutral Fair Highly leveraged
Source: S&P Global Ratings.

Table 3

Our Key Qualitative Considerations For Liquidity
Banking relationships
Number of banks with ongoing relationship
The stability of relationship with core banks
Interest rate compared to PBOC benchmark rate and peers, and the trend of interest rate
Fixed assets available for pledge
Track record of rolling over short-term bank debt
The amount of secured short-term debt
The amount and trend of undrawn credit lines
Credit market standing
Rating level
Number and amount of issuances in credit markets, both onshore and offshore
Track record of long-term bond issuance
Coupon rate and trend of cost of long-term bond
Track record of extending puttable bonds
Coupon rate and trend of cost of long-term bond
Track record of extending puttable bonds
Investor feedback
The likelihood to absorb high-impact, low-probability events, without refinancing
Flexibility to lower capital spending or asset disposals to supplement liquidity
Amount of committed credit lines and cash on hands vs. debt maturity
Risk management
Track record of risk management and execution of refinancing plans
Management’s risk awareness and appetite
Willingness to scale down capex and acquisition spending to maintain liquidity position
Ability to anticipate potential setbacks and take necessary actions to maintain liquidity position
Covenants
Maintenance and incurrence covenants
Covenant headroom
Source: S&P Global Ratings.

This report does not constitute a rating action

Primary Credit Analysts:Clifford Kurz, Hong Kong (852) 2533-3534;
Clifford.Kurz@spglobal.com
Sophie Lin, Hong Kong (852) 2533-3544;
sophie.lin@spglobal.com
Secondary Contact:Flora Chang, Hong Kong + 852 2533 3545;
flora.chang@spglobal.com
Research Assistant:Joy Zhang, Hong Kong

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