Health and Happiness (HH) International Outlook Revised To Positive On Good Operating Cash #BB# Ratings Affirmed

Stocks and Financial Services Press Releases Wednesday February 28, 2018 17:06
HONG KONG--28 Feb--S&P Global Ratings

HONG KONG (S&P Global Ratings) Feb. 28, 2018--S&P Global Ratings said today that it had revised its rating outlook on Health and Happiness (H&H) International Holdings Ltd. (H&H) to positive from stable. At the same time, we affirmed our 'BB' long-term corporate credit rating on H&H and our 'BB' long-term issue rating on the company's outstanding senior unsecured notes.

H&H manufactures and distributes infant milk formula (IMF) products and other baby products in China. It also provides vitamin, herbal, mineral, and health supplement (VHMS) products in Australia, China, and globally following its acquisition of Swisse Wellness Group in September 2015.

We revised the outlook to positive to reflect our view that H&H's has solid growth prospects and will likely maintain steady operating cash flows over the next 12 months. The company's debt leverage and serviceability could therefore continue to improve over the period. We also anticipate that H&H will be more disciplined with capital investment over the next 12 months, after its full integration of Swisse.

We believe H&H's good growth trajectory will persist over the next 12-24 months, driven by stronger marketing efforts. The company has increased spending on advertising and marketing for both its IMF and VHMS businesses since the second half year of 2017. Growth will also be driven by Chinese consumers' preference for premium IMF products and rising health awareness that has fueled the popularity and penetration of VHMS products. Our base case assumes H&H's revenue will grow 7%-12% in 2018 and 2019, after a strong growth of about 22% over the first nine months of 2017.

H&H's operating cash flow will likely remain steady over the next 12-24 months, although its profitability could fall amid increasing spending on marketing. Stronger growth prospects owing to the company's rising brand-building efforts and good working capital management should more than offset the impact of a lower profit margin. We expect H&H's EBITDA margin to deteriorate to 24%-27% in 2018 and 2019, from our estimate of close to 30% in 2017.

Disciplined capital investment and shareholder returns also underpin our anticipation of H&H's lower debt leverage. The company operates an asset-light business model by outsourcing the majority of its product manufacturing to its suppliers globally. We believe the company's capital expenditure will remain limited over the next two years. Our base case also assumes limited acquisitions by H&H over the next 12-24 months.

We affirmed the ratings because we expect H&H to maintain its market position, good revenue diversity, and satisfactory operating efficiency over the next 12-24 months. However, intense competition in the fragmented IMF and VHMS markets in China and regulatory uncertainty associated with cross-border e-commerce could pose a challenge to the company's growth and profitability. In addition, H&H's high financing costs will constrain its overall creditworthiness, in our view. We anticipate that the company's EBITDA interest coverage will improve but stay below 6.0x over the next 12 months.

We expect H&H to face rising competition in the fast-growing high-end IMF product segment, with more global brands entering the market. Competition will also come from global IMF brands expanding in China through cross-border e-commerce. Although H&H has an established market position in the high-end product category in China, it directly competes with strong global peers such as Nestle S.A., Abbott Laboratories, and Danone.

Risk to H&H from tightening regulations for the distribution of VHMS products via e-commerce remains, albeit moderating. The Chinese government has extended the grace period to implement the new requirement for the distribution of health supplements through cross-border e-commerce to Dec. 31, 2018, from Dec. 31, 2017. The extension will give Swisse more time to adjust its distribution strategy in China. Nevertheless, any material change in policies or tightening of regulations on parallel trading or cross-border e-commerce could materially weaken Swisse's sales and profitability.

The positive outlook on H&H reflects our expectation that the company could continue its strong growth prospects and steady operating cash flows, which should help reduce its debt leverage and improve its EBITDA interest coverage over the next 12 months. We also expect H&H to be more disciplined with capital investment over the next 12 months.

We could revise the outlook to stable if H&H's debt-to-EBITDA ratio exceeds 3.0x. This could happen if the company's revenue declines materially or its EBITDA margin falls below 20%, possibly due to intense competition, the negative impact from changes in regulations, or difficulties in expanding Swisse's business. This could also happen if H&H undertakes more aggressive debt-funded expansion and shareholder returns than we expect.

We could raise the rating if H&H's operating performance and free operating cash flow improve and lead to better debt leverage and serviceability. This could also happen if H&H optimizes its capital structure by using cash to reduce its debt balance and lowering its financing costs. EBITDA interest coverage ratio approaching 6.0x while the debt-to-EBITDA ratio sustains below 2.5x over the next 12 months would indicate such improvement.


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