Key Takeaways
- Credit quality is deteriorating for Greater China consumer firms due to rising input costs and weakening demand, amid inflation and a soft economy.
- We're likely to revise down our 2022 and 2023 revenue expectations for about 40% of rated entities within the Greater China consumer sector in the next three to six months; about one-quarter of these companies also face lower margins.
- Most exposed entities are those related to travel, leisure, and restaurants, such as Melco, Haidilao, and China Tourism.
Rising costs and slipping demand are hitting the credit profiles of Chinese consumer-facing companies. Over the next three to six months, we will likely revise downward our revenue or profit expectations for about 40% of rated consumer entities in Greater China. The effects will be most acute for firms with limited ability to pass through costs to their customers, or which sell highly discretionary goods and services.
Macroeconomic trends are working against issuers. In May, S&P Global Ratings cut its 2022 forecast for China GDP growth to 4.2%, from 4.9%. Our downside scenario sees growth sliding as low as 3.5%. The possibility that authorities will roll out more lockdowns in large Chinese cities is the key risk factor, in our view (see "China's COVID Policy To Further Weigh On Economy, Credit," published May 15, 2022, on RatingsDirect).
More lockdowns would hit demand for consumer goods. The controls would raise unemployment, upset supply chains, increase input costs, and curtail capital market access, among other effects. We break down these influences and look at how they might hurt the credit standing of rated consumer entities. While this discussion focuses on mainland China, the company data in charts and tables span Greater China.
Chart 1
Factors That Weigh On Revenues
Shrinking disposable income and weakening consumer sentiment are the two biggest factors weighing on the topline of rated consumer firms. China's zero-COVID policy amplifies these strains, which surfaced in late 2021. Lockdowns prompted many businesses to suspend operations, with many wage earners and laborers going without income for weeks or months. This ate into consumers' spending power.
Our base case assumes revenue will gradually recover from the third quarter of 2022. However, Shanghai's developing COVID-19 measures highlight the strong risk that mobility controls can strike anytime, hitting firms and the economy. A V-shaped rebound is unlikely, even though issuers can now better manage supply chains and regional governments are providing consumption vouchers to spur spending.
Chart 2
The soft economy has revenue implications for consumer firms. We group companies with downward revenue revision risk into two broad categories. The first group comprises issuers vulnerable to restrictions on people movement, such as Macau gaming operators Melco Resorts and Studio City, duty-free retailer China Tourism Group, and food delivery and local service provider Meituan.
The second group contains companies that sell largely discretionary goods, such as apparel retailers Vipshop and Bosideng, or auto seller Zhongsheng. Other entities will likely be hit by an emerging preference to buy lower-ticket items. Such firms include the full-service caterer Haidilao and the retail store chain Golden Eagle.
Table 1
| Entities With High Revenue Revision Risk | ||||||
|---|---|---|---|---|---|---|
| Rating | Comments | |||||
| Melco | BB-/Negative/-- | Reliance on China visitors hurts Macau casino operators, with travel hit by lockdowns and restrictions on visa approvals | ||||
| Studio City | B+/Negative/-- | Reliance on China visitors hurts Macau casino operators, with travel hit by lockdowns and restrictions on visa approvals | ||||
| Vipshop | BBB/Stable/-- | Hit by weaker consumer spending power; intense competition from other online retailers | ||||
| China Tourism Group | A-/Stable/-- | Lockdowns affecting spending on travel | ||||
| Zhongsheng | BBB-/Positive/-- | New car sales in decline, affected by both weaker consumer sentiment and chip shortage. Aftersales should be steady | ||||
| Haidilao | BBB-/Stable/-- | Catering sector is struggling, especially full-service restaurant operators; Haidilao has a limited home-delivery service | ||||
| Golden Eagle | BB+/Stable/-- | Store closure during COVID, discretionary items see slower growth | ||||
| Meituan | BBB-/Negative/-- | Key cash flow driver instore/hotel segment will get hit by lockdowns and weak consumption | ||||
| Bosideng | BBB-/Stable/-- | Product upgrade/hikes to the average selling price could be slow amid weaker pockets for financial year 2023 | ||||
| Note: See Appendix for the full legal name of each entity. Source: S&P Global Ratings. Source: S&P Global Ratings. | ||||||
Some consumer groups will only see a small dent to their credit strength even as revenue falls. Online apparel retailer Vipshop expects second-quarter revenue to drop 20%-25%. While a sharp rebound is not likely for the rest of 2022, the firm's cash-generation ability and strong balance sheet will support our rating on the company, in our view.
We have revised down our revenue forecast for JD.com (see "JD.com 'BBB+' Rating Affirmed On Resilient Business Model; Outlook Positive," June 7, 2022) while maintaining our positive rating outlook. The company's business fundamentals remain intact, in our view, and may even be strengthening. This is despite significant COVID-19-related disruptions starting early this year.
Elsewhere, our rating on Meituan focuses on its ability to manage losses on its new business initiatives, and adjust its investment decisions to reflect evolving pandemic rules (see "Managing Investment Risk, COVID Key For Meituan," June 7, 2022).
While Sales Falter, Costs Rise
There are multiple facets to firms' cost increases. On top of typical inputs that are affected by inflationary pressure, firms will have to digest existing inventory that was built during weaker demand periods.
The key is whether companies can pass on rising expenses to consumers. This is not easily done without squeezing demand. The China consumer price index will likely not rise meaningfully in 2022, suggesting that issuers will largely bear the burden of rising costs.
Within our coverage, we view restaurants, gaming operators, and producers of discretionary products as having the weakest cost pass-through ability. Hot-pot chain operator Haidilao manages costs by selling low-cost food items, managing portion sizes, and by innovating products that command higher prices. Along with rising food costs, the restauranter also faces higher energy expenses with utility bills comprising about 8% of operating costs (excluding depreciation & amortization).
Entities selling discretionary items--such as Bosideng or Midea--will also face difficulty passing on costs as tough competition and weaker consumer sentiment set in.
Chart 3
Across our coverage, issuers are increasingly prioritizing profits over growth to preserve margins. Internet platforms are rechanneling marketing dollars away from acquiring new users, and toward raising the average revenue and spending frequency of existing users.
Entities will continue to improve production efficiency. They will do this by achieving economies of scale, raising automation rates, and streamlining operations. A minority of companies are using short-term instruments to fund long-term liabilities. This reduces immediate interest costs, but it raises liquidity and refinancing risks.
Ratings Buffers Set For A Squeezing
So far this year, we have only taken negative rating actions on two firms: Haidilao and Health and Happiness (see "Haidilao International Downgraded To 'BBB-' On Weakening Profitability; Outlook Stable," March 28, 2022, and "Health and Happiness (H&H) International Outlook Revised To Negative On Weaker Performance; 'BB+' Rating Affirmed," April 4, 2022). However, weaker revenues and rising costs will likely narrow the rating buffers on many Chinese consumer firms in the second half of 2022. While our base case is that some recovery will emerge in the second half, macro conditions remain decidedly soft. This gives Chinese consumer firms little leeway to manage increasingly pernicious inflation effects.
Table 2
| Cost And Demand Effects On Rated Entities | ||||||
|---|---|---|---|---|---|---|
| Grouped by strong, moderate, and mild effects | ||||||
| Rating | Comments | |||||
| Entities with steep revenue and cost effects | ||||||
| China Modern Dairy | BBB/Stable/-- | Hard to pass through risings cost to parent and major buyer Mengniu | ||||
| Fufeng | BBB-/Stable/-- | Cost pass-through is opportunistic and with a time lag. Market position helps negotiation with downstream packaged food firms. Corn and coal make up three-quarters of production cost. | ||||
| Health and Happiness | BB+/Negative/-- | Higher raw material costs not easy to pass through to consumers during a soft economy and amid intense competition | ||||
| Entities with moderate revenue and cost effects | ||||||
| Li & Fung | BBB-/Negative/-- | Trading business could be affected given reliance on U.S., where demand is weakening; in-country logistics hit by China's COVID lockdowns although we expect some catch-up in the second half of 2022 | ||||
| Bright Food | BBB/Stable/-- | Scope for cost pass-through varies by product; company is reducing expenditure | ||||
| Midea Group | A/Stable/-- | Purchases of some appliances may be boosted by lockdowns although not enough to offset consumers' generally weaker purchasing power. Cost trends and a weak property market should ensure the current trend for margin shrinkage in the consumer appliance segment will continue | ||||
| JD.com | BBB+/Positive/-- | Order cancelation was high in April, but with some improvement in May. Margin deterioration is likely with the firm generating most growth from lower-margin categories such as supermarket display, while volumes slow for higher-margin categories that target discretionary spending | ||||
| Tingyi | A-/Stable/-- | Raising noodle prices show entity has some scope to pass along cost hikes, although likely not at the rate to cover the issuer's increased costs | ||||
| Entities with mild revenue and cost effects | ||||||
| COFCO (Hong Kong) | A-/Stable/-- | Entity's business model of food commodity trading enables them to largely pass through the costs | ||||
| WuXi AppTec | BBB-/Positive/-- | Order book retains a strong momentum | ||||
| Thevelia Holdings | B/Stable/-- | Current climate may be beneficial as businesses seek to cut costs with outsourcing | ||||
| WH Group | BBB/Stable/-- | Weaker pork prices this year helps margins | ||||
| Jardine Matheson | A+/Stable/-- | Retail category is well positioned to pass on rising costs, while the conglomerate's property business and Indonesia exposure are solid. The entity's commodity arm (Astra) may benefit from higher commodity price. All-in, inflationary effects should be neutral | ||||
| Mengniu | BBB+/Stable/-- | Raw milk producer helps to absorb some costs, which benefits Mengniu and Yili. Underlying demand is firm although demand for premium products might slow | ||||
| Inner Mongolia Yili Industrial Group | A-/Stable/-- | Raw milk producer helps to absorb some costs, which benefits Mengniu and Yili. Underlying demand is firm although demand for premium products might slow | ||||
| Note: See Appendix for the full legal name of each entity. Source: S&P Global Ratings. Source: S&P Global Ratings. | ||||||
Table 3
| Issuers That Will Likely Experience A Weakening Of Credit Metrics | ||||||
|---|---|---|---|---|---|---|
| Key metrics affected | Metric effects | |||||
| Melco Resorts | Debt/EBITDA, cash burn duration | Longer-than-expected low revenue periods could push up leverage and delay recovery prospects in 2023 | ||||
| China Tourism Group | Debt/EBITDA | Softer demand on discretionary travel amid lockdowns could push up leverage, with the firm adding capital spending | ||||
| Haidilao | Debt/EBITDA, table turnover | Table turnover has dropped since late March on lockdowns. Prolonged lockdowns could slow deleveraging | ||||
| Health and Happiness | Debt/EBITDA | Weaker demand could affect infant milk formula business further, particularly for the H&H products that face strong competition in China. EBITDA could come in lower than expected | ||||
| Meituan | Free operating cash flow | Weakening instore demand; firm may offset the lost sales by cutting investment | ||||
| Zhongsheng | Debt/EBITDA | Weaking demand for vehicles | ||||
| Note: See Appendix for the full legal name of each entity. Source: S&P Global Ratings. | ||||||
Appendix
Chart 4a
Chart 4b
Chart 5
Full legal names of issuers cited:
Bosideng--Bosideng International Holdings Ltd.
Bright Food--Bright Food (Group) Co. Ltd.
China Modern Dairy--China Modern Dairy Holdings Ltd.
China Tourism--China Tourism Group Corp. Ltd.
COFCO--COFCO (Hong Kong) Ltd.
Fufeng--Fufeng Group Ltd.
Golden Eagle--Golden Eagle Retail Group Ltd.
H&H--Health and Happiness (H&H) International Holdings Ltd.
Haidilao--Haidilao International Holding Ltd.
Jardine Matheson--Jardine Matheson Holdings Ltd.
JD--JD.com Inc.
Li & Fung--Li & Fung Ltd.
Meituan--Meituan
Melco--Melco Resorts (Macau) Ltd.
Mengniu--China Mengniu Dairy Co. Ltd.
Midea--Midea Group Co. Ltd.
Studio City--Studio City Co. Ltd.
Thevelia--Thevelia Holdings Ltd.
TIngyi--Tingyi (Cayman Islands) Holding Corp.
VIPS--Vipshop Holdings Ltd.
WH--WH Group Ltd.
WuXi AppTec--WuXi AppTec Co. Ltd.
Yili--Inner Mongolia Yili Industrial Group Co. Ltd.
Zhongsheng--Zhongsheng Group Holdings Ltd.
Writing: Jasper Moiseiwitsch
Digital design: Evy Cheung
Related Research
- Vipshop 'BBB' Rating Affirmed On Resilient Market Position And Solid Balance Sheet; Outlook Stable, June 17, 2022
- JD.com 'BBB+' Rating Affirmed On Resilient Business Model; Outlook Positive, June 7, 2022
- China's COVID Policy To Further Weigh On Economy, Credit, May 15, 2022
- Mengniu To Weather The Inflation Storm, April 1, 2022
- Economic Outlook Emerging Markets Q2 2022: Growth Slows Amid Higher Commodity Price Inflation, March 29, 2022
- China-Based Apparel Maker Bosideng International Holdings Ltd. Rated 'BBB-'; Outlook Stable, April 18, 2022
- Health and Happiness (H&H) International Outlook Revised To Negative On Weaker Performance; 'BB+' Rating Affirmed, April 4, 2022
- Haidilao International Downgraded To 'BBB-' On Weakening Profitability; Outlook Stable, March 28, 2022
- Haidilao International Ratings Placed On CreditWatch Negative Following Profit Warning, Feb. 22, 2022
- Meituan 'BBB-' Ratings Affirmed With Limited Rating Buffer; Outlook Negative, Feb. 22, 2022
- Inner Mongolia Yili Industrial Group Ratings Outlook Revised To Stable On Financial Discipline; 'A-' Rating Affirmed, Feb. 17, 2022
- Melco And Studio City Ratings Affirmed With Negative Outlook; Studio City's Proposed Senior Secured Notes Rated 'B+', Feb. 7, 2022
- China Consumer Products And Retail: Dark Clouds Linger For Longer, Jan. 24, 2022
- Thevelia Holdings Ltd. Rated 'B' With Stable Outlook; First-Lien Debt Assigned 'B' Rating, Jan. 24, 2022
- China Power Outages Add Dark Clouds To An Already Weakening Consumer Sector, Nov. 11, 2021
This report does not constitute a rating action.
| Primary Credit Analyst: | Sandy Lim, CFA, Hong Kong + 852 2533 3578; sandy.lim@spglobal.com |
| Secondary Contacts: | Aras Poon, Hong Kong (852) 2532-8069; aras.poon@spglobal.com |
| Manqi Xie, CFA, Hong Kong + 85225328001; manqi.xie@spglobal.com | |
| Flora Chang, Hong Kong + 852 2533 3545; flora.chang@spglobal.com | |
| Billy Ng, Hong Kong +852 2533 3507; billy.ng@spglobal.com | |
| Research Assistant: | Victor Kong, Hong Kong |
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