February 20, 2017 / 9:56 AM / 5 months ago

Fitch Publishes Vipshop's Rating of 'BBB+'; Outlook Stable

15 Min Read

(The following statement was released by the rating agency) HONG KONG, February 20 (Fitch) Fitch Ratings has published Chinese online retailer Vipshop Holdings Limited's (Vipshop) Long-Term Foreign-Currency Issuer Default Rating (IDR) of 'BBB+' and senior unsecured rating of 'BBB+'. The Outlook for the IDR is Stable. Vipshop's ratings are supported by its large operating scale, strong brand recognition, as well as its merchandising and fulfilment capabilities, which defend its business model and market leadership in online retail of discount apparel in China. Furthermore, the company has decent EBITDA margins, strong operating cash flows and a healthy financial profile. Vipshop's ratings are constrained by its modest operating scale, relatively short history of profitability, and the high pace of change in the competitive industry. KEY RATING DRIVERS Leading Apparel Retailer in China: Vipshop is the leading apparel retailer in China, with more than CNY48.3bn in gross merchandise value, net of returns (net GMV) in 2015. It is also the dominant player in China for both discount apparel retail and online flash sales. Under the company's flash sale model, the company procures excess inventory from brands and sells them on its website for a limited time at discounted prices. Fitch sees Vipshop's strong warehousing and fulfilment infrastructure as a key barrier to entry, which differentiates the company from competitors in the apparel category. In 2015, the company ranked number four among all business-to-consumer (B2C) retailers in China, according to iResearch, and was the leading online retailer for apparel. Fast-Growing Markets: Fitch expects Vipshop to benefit from the rapid growth in both online and discount apparel retail in China, given its leadership position and lack of a close competitor. Frost and Sullivan forecasts online apparel retail sales in China to increase at 18% CAGR between 2015 and 2020 and surpass offline sales by 2020. At the same time, Frost and Sullivan also expects the discount apparel retail market to expand at 15% CAGR, compared to 11% projected for overall apparel retail. Healthy Margins and Cash Flow: Vipshop's EBITDA margin of 6%-7% is lower than most investment-grade brick-and-mortar retailers, but strong compared to most online retailers in China, many of which are struggling to break even. Fitch believes it is possible for the company to further improve its margins by lowering fulfilment costs as it grows. Furthermore, Vipshop's capex cycle peaked in 2015 and management plans to reduce capex gradually from 2016. Fitch expects Vipshop to report positive FCF from 2017. Strong Financial Profile: Vipshop has strong credit metrics that are commensurate with investment-grade retailers. Fitch expects Vipshop's FFO-adjusted net leverage to decline to below 1.0x by 2018, from 2.0x in 2015, even after adjusting for the negative working capital. Vipshop's coverage ratios are also higher than retailers in the 'BBB' category given its negligible reliance on operating leases. Internet Financing Manageable: Vipshop has started internet financing businesses, offering credit to both consumers and suppliers, mostly using its own financial resources. The company believes these initiatives will enrich the ecosystem and increase supplier and consumer loyalty. In January 2017, Vipshop issued its first consumer finance asset-backed securities with outstanding amount of CNY300m. Fitch views the financial risk to be manageable for now as Fitch expects total loans outstanding to account for a low to mid-single-digit percentage of net GMV in 2016; however the company's exposure to regulatory risk will increase. Short Track Record, Industry Risk: Vipshop's ratings are constrained by its relatively short track record - the company began operations in 2008 and turned profitable only in 2013. In addition, its reliance on a single format - online flash sales - means that it may be negatively impacted by changes in consumer or supplier behaviour. Vipshop's operating scale - as measured by EBITDA - is also smaller compared to other investment-grade retailers. DERIVATION SUMMARY Vipshop is better-positioned relative to rated brick-and-mortar retailers in China, due to its larger operating scale, stronger market position and lower leverage. Vipshop is rated well above Chinese department store operators such as Golden Eagle Retail Group Limited (BB-/Negative) and Parkson Retail Group Limited (B-/Negative), due to its stronger market position and superior earnings outlook, as well as its larger operating scale. It is rated two notches above Lotte Shopping Co. Ltd (BBB-/Stable) due to its stronger financial profile. Vipshop's ratings are below the Chinese internet majors such as Alibaba Group Holding Limited (A+/Stable) and Baidu., Inc (A/Stable) as it has a much smaller operating scale and narrower business focus. Vipshop is rated at a similar level to major US retailers, such as Nordstrom, Inc. (BBB+/Stable), because it has a smaller operating scale but lower leverage, strong market position, and better growth prospects. No country-ceiling, parent/subsidiary or operating environment aspects impacts the rating. KEY ASSUMPTIONS Fitch's key assumptions within the rating case for the issuer include: - 30% revenue growth in 2017, then 15% growth from 2017 - EBITDA margin of 7% in 2017-2019 (2015: 7%) - Capex of CNY2bn-3bn per year in 2017-2019 - No common dividends paid RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to Positive Rating Action - No positive rating action is envisaged until the company reaches significantly larger scale while remaining FCF positive Future Developments That May, Individually or Collectively, Lead to Negative Rating Action - EBITDA margins sustained below 7% (2015: 7%) - FFO-adjusted net leverage sustained above 1.5x (2015: 2.0x) after the capex intensive period - Sustained negative FCF LIQUIDITY Healthy Liquidity: At the end-3Q16, Vipshop had CNY4.9bn in cash, CNY0.1bn in financial investments and CNY3m in short-term bank borrowings. Vipshop may have to redeem its 1.5% convertible senior notes with USD632.5m (CNY4.3bn) face value in March 2017 should noteholders exercise their options. The company is looking at various options to refinance the notes. Fitch expects the company will be able to do so successfully, given its strong financial profile. Contact: Primary Analyst Yee Man Chin Director +852 2263 9696 Fitch (Hong Kong) Limited 19F Man Yee Building 68 Des Voeux Road Central Hong Kong Secondary Analyst Kelvin Ho Director +852 2263 9940 Committee Chairperson Kalai Pillay Senior Director +65 6796 7221 Media Relations: Wai-Lun Wan, Hong Kong, Tel: +852 2263 9935, Email: wailun.wan@fitchratings.com. Summary of Financial Statement Adjustments - Share-based compensation has been stripped out of SG&A expenses and EBITDA - Cash balance has been adjusted to reflect the negative working capital cycle. 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