Fitch Assigns Midea's Proposed USD Notes Expected Rating
Midea Investment is a wholly owned subsidiary of Midea Group Co., Ltd. (Midea; A-/Stable), which is providing an unconditional and irrevocable guarantee for the medium-term note programme. The programme is rated at the same level as Midea's senior unsecured rating to reflect this guarantee. The final rating on the US dollar notes is contingent upon receipt of documents conforming to information already received.
The rating assigned to the medium-term note programme is no assurance that notes issued under the programme will be assigned a rating, or that the rating assigned to a specific issue will be the same as that of the programme.
Midea's ratings are driven by the company's position as an innovative, leading Chinese consumer appliance maker, its broad product and geographical diversification, its strong distribution and sales network, a positive long-term industry outlook in China, and the company's financial metrics. The ratings also take into consideration Midea's limited international brand value and the cyclicality of the industry.
KEY RATING DRIVERS
Kuka Acquistion Neutral to Ratings: Fitch believes Midea proposed acquisition of Kuka AG (Kuka/Not Rated) does not affect its ratings as Midea has sufficient internal financial resources to fund this acquisition. This acquisition will provide some business diversification and will not impact on Midea's ability to generate free cash flow (FCF). Please see Midea Has Financial Resources to Fund Proposed Kuka Acquisition, dated 20 March 2016.
Market Leading, Innovative Manufacturer: Midea is one of the largest consumer appliance manufacturers in China. It ranks among the top four in terms of sales value in most of the major appliances (including air conditioners, refrigerators and washing machines), and consistently ranks first in small appliances. The company's strong market share is driven mostly by its vast distribution network, well-known brand name, and its ability to introduce new products and features through extensive R&D.
Strong Distribution and Sales Network: Midea has an extensive distribution network, with full coverage of the first- and second-tier markets and more than 95% coverage of the third- and fourth-tier markets. The company has a comprehensive marketing network of more than 15,000 stores and over 70,000 regional distributors, as well as long-term strategic relationships with large home-appliance stores and online shopping platforms.
Fitch believes Midea's vast network allows the company to maximise its reach to customers both online and offline. The company also has its own logistics business, and is establishing an integrated O2O (online-to-offline) business platform, which is an important strategy to succeed in the consumer appliance industry.
Positive Industry Outlook: Fitch expects sales in China's consumer appliance sector to register mid- to high-single-digit growth in the next few years, driven mostly by replacement demand and product upgrades as a result of higher disposable income, urbanisation and modernisation in the country. Sales of small appliances are likely to increase faster than major appliances, given their faster replacement cycles and much lower penetration rates. Midea, as a leading market player in the industry and dominant producer in the small appliance sector, is poised to benefit from the positive industry trend.
Geographical and Product Diversification: Midea has the widest range of product offerings in the world, covering both large and small appliances. The company also derives close to 40% of sales and over 30% of gross profit overseas. Apart from China, Midea also has production facilities in Vietnam, India, Egypt, Belarus, Argentina, Brazil and Chile, along with R&D centres in a number of countries including Japan, Italy and the US. Fitch believes the acquisition of Toshiba's white goods department would improve its overseas market presence and distribution capability.
Net Cash, FCF Generation: Midea has been generating positive FCF since 2012, and has remained in a net cash position since 2013. Fitch does not expect this to change because of the company's ability to maintain stable margins and low capex. Midea implemented a number of measures to improve profitability in 2014, including streamlining the product portfolio to eliminate low-margin products, increasing automation at its production facilities, introducing new higher-end products, and standardising component usage. As a result, in 2015 its EBITDA margin improved to 11.4% from that of 10.8% in 2014.
Limited End-Market Diversification: Midea sells its products primarily in China, which leaves it vulnerable to consumer cycles in the country. This constraint on its rating is partly offset by the sheer size of China's consumer appliance market, which accounts for about half of the global market, and the positive industry outlook.
Weak International Brand: Midea's presence internationally is much weaker than that in China. Its own branded products (including products marketed under Midea for export and Midea-owned brands) accounted for approximately 40% of its total overseas sales in 2015. Fitch considers this a constraint on the ratings. Brand recognition is an important measure of success for consumer appliance producers as strong brands are generally associated with product quality and promote customer loyalty, which are essential in maintaining market share and sales growth.
Fitch's key assumptions within our rating case for the issuer include:
- Slower sales growth for 2016-2017 in the mid- to high-single-digits in each product segment due to continued de-stocking in the sector and slower economic growth
- Gradual improvement in margins due to streamlining of product portfolio, component standardisation, and an increasing focus on more value-added products with higher prices
- Capex spending to be around CNY3.5bn in 2016, followed by CNY3.0bn a year thereafter.
Positive: Developments that may, individually or collectively, lead to positive rating action include:
- A strong international brand comparable with those of its global peers and increasing amount of sales generated from its own brand overseas
- An increasd market share without compromises in profit margins and financial profile.
Negative: Developments that may, individually or collectively, lead to negative rating action include:
- Sales growth that is weaker than that of the industry
- EBITDA margin sustained below 9% (2015: 11.4%)
- FCF margin sustained below 3% (2015: 13.9%)