Corporate China
Midea Group Co., Ltd.
Ratings Overview
Issuer Rating ▪ Pengyuan International has assigned a first-time global scale long-term issuer LT Issuer Credit Rating A credit rating (LTICR) of ‘A’ to Midea Group Co., Ltd. (Midea), with a stable outlook.
Outlook Stable ▪ The rating reflects Midea’s position as the world’s leading home appliance provider with strong product offerings, wide geographical exposure, exceptional leverage profile and long record of low volatility operations. These strengths, however, are partly offset by the intense competition from both its Contents domestic and international rivals. ▪ Midea mainly engages in the production and distribution of heating, ventilation and air-conditioning (HVAC); and other major appliances such as refrigerators Key Rating Drivers ...... 2 and washing machines; and small appliances such as kettles and fans. It also Business Profile……………………...3 provides different robotics and automation (R&A) systems. The Company offers its products under the brand names of Midea, Little Swan, Toshiba, Financial Profile……………………...7 Clivet, KUKA and several others. The Company has operations in more than Liquidity ...... 9 200 countries and regions. As of FY2019, the Company had 58% of revenue derived from the mainland China and the remaining balance came from the Company Background ...... 10 rest of the world. Peer comparison...... 10 Rating Outlook Rating Scores Summary ...... 13
Related Criteria ...... 13 ▪ The stable outlook for Midea reflects our expectation that the Company will be able to maintain its market position as the leading major appliance producer in the world, while maintaining the same level of profitability and generating positive cash flows. Contacts ▪ We would consider upgrading Midea’s issuer credit rating if its credit profile improves substantially, which could be caused by: 1) an expansion in its EBITDA margin to above 14% on a sustainable basis; 2) strengthened product Primary Analyst offering with more financially successful premium priced products; and 3) Name Jonathan Joseph Tai, CFA improved business diversity via increasing its international presence or finding Title Analyst financial success in non-home-appliance businesses. Direct +852 3615 8276 Email [email protected] ▪ We would consider downgrading Midea’s issuer credit rating if its credit profile deteriorates substantially, which could be caused by: 1) a contraction in its Secondary Analyst EBITDA margin to below 8% on a sustainable basis; 2) rapid decrease in Name Brian Lam market share for key products; and 3) weakening liquidity and leverage Title Director position due to aggressive acquisitions. Direct +852 3615 8339 Email [email protected] Financial Summary
Exhibit 1: Financial Ratios 2018A 2019A 2020F 2021F 2022F Debt/EBITDA -1.2x -1.9x -1.8x -2.0x -2.3x EBITDA Interest Coverage 40.6x 36.1x 24.9x 27.7x 28.6x Gross Debt/Capitalisation 41.4x 40.2x 43.4x 41.0x 38.8x FFO/Debt NM NM NM NM NM OCF/Debt NM NM NM NM NM FCF/Debt NM NM NM NM NM ROIC 17.9% 18.0% 18.3% 18.3% 17.4% NM - Not meaningful. Sources: Company, Pengyuan International
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Key Rating Drivers
Credit Strengths
• Leading market position with a strong and diverse product portfolio. Midea is the largest major appliance company, not just in China but also worldwide. It reported a revenue of RMB279 billion in FY2019, nearly 40% higher than the next two home appliance focused companies in the world: Haier Smart Home and Gree Electric. Midea has a strong product portfolio that covers all types of major appliances with multiple price levels for different consumer segments, and offers a wide collection of small appliances, including electric fans, rice cookers and water purifiers. A lot of the major appliance products, such as air conditioners, laundry appliances and refrigerators rank either first or second place in retail sales market share in China. Notably, the Company has also strong online presence and has the highest online sales volume in China among household appliance manufacturers.
• Long track records of above-industry growth with low volatility margins. The Company generated 7% year-on- year revenue growth after its major acquisitions occurred in FY2016 and FY2017, materially higher than the retail sales growth data of 1% and -2.2%, according to China Household Electric Appliance Research Institute and the National Household Electrical Appliance Industry Information Center in 2018 and 2019. Its market share of offline air- conditioners increased to 28.9% in 2019 from 24.6% in 2017. In addition, the Company has a track record of maintaining stable gross and EBITDA margins. Excluding one-time gains and losses and non-operating items, adjusted EBITDA margins remained in a tight range of 10.7-12.3% between FY2014 and FY2019. Undeterred by the coronavirus pandemic’s outbreak, the Company is showing exceptional stability. The Company is expected to maintain a flattish adjusted EBITDA margin of 11.2% in FY2020, extrapolating from the solid three quarters of financial performance in 2020.
• Strong leverage profile, strong cash flow generating capability. In spite of all the debt issuance, shares repurchase, increasing dividend pay-outs and high-profile acquisitions over the last few years, Midea was generally expanding its net cash position and improving its leverage profile. The Company increased its total debt by 14% in FY2019 and another 31% in the six months of 2020. Its total financial assets increased by a larger amount and faster rate of 31% and 24% in FY2019 and the first six months in 2020. As a result, the Company’s net cash position has expanded since 2018 with a stronger net debt-to-EBITDA and FFO-to-net debt ratios, suggesting that it has a strong capability to service its debt obligations. Looking forward, we expect some significant events and projects that have occurred but yet to be officially released in the interim periods of 2020, including the acquisition of Hiconics, the construction of a research and development centre in Shanghai and the pending spin-off of Mei-Zhi Photoelectric Technology. These projects will not exert significant pressure on the Company’s financials due to their relatively small size. In our view, the Company’s leverage profile and its cash flow generating ability will continue to remain very healthy and strong.
Credit Weaknesses
• Strong competitors with unique advantages. The home appliance industry is crowded with strong domestic and international competitors, while these competitors might be smaller in size, a lot of them have their niche and unique advantages over Midea. For example, Daikin and Dyson have arguably stronger brand images in specific regions and have very distinctive market niches. These competitors have become an immense force that prevents Midea from expanding market share and entering overseas markets. In addition, some competitors have enough pricing power that can induce Midea into a pricing competition. As technology changes, new competitors from different industries, such as Xiaomi, might enter the market with cross-industry advantages, posing as a threat to the Company.
• Increasing risk and reliance associated with acquisitions. Midea has been active in mergers and acquisitions over the last few years to improve its production efficiency, enhance its research and development capability, develop new segments, strengthen product offerings, and expand into new markets. These acquisitions have not only increased the Company’s investment cash outflow, but have also increased operating risks, as synergies generated from these mergers and acquisitions may not be as significant as the Company had expected. These acquisition targets may have a lower-than-expected sales performance and lose money, or a substantially high premium that may exert pressure on the Company’s creditworthiness.
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Exhibit 1: Key Credit Metrics (RMB mn) 2018A 2019A 2020F 2021F 2022F Financials and Profitability Revenue 259,665 278,216 278,357 306,259 328,271 EBITDA 28,570 31,815 31,092 34,904 37,844 EBITDA Margin 11.0% 11.4% 11.2% 11.4% 11.5% Return on assets (ROA) 9.8% 9.8% 9.0% 8.4% 8.4% Return on invested capital (ROIC) 17.9% 18.0% 18.3% 18.3% 17.4% Cash Flow Measures Funds from operations (FFO) 25,926 28,876 28,120 32,903 35,979 Operating cash flows (OCF) 27,712 37,320 20,981 27,806 31,272 Free cash flow (FCF) 22,100 33,868 16,207 23,247 26,233 Discretionary cash flow (DCF) 13,501 23,693 4,888 12,004 14,003 Capital expenditure 5,612 3,452 4,774 4,559 5,039 Balance Sheet Measures Cash and liquid investments 100,032 132,240 150,343 170,391 192,529 Excess cash 98,906 131,807 149,943 169,991 192,129 Total debt 63,350 72,123 94,481 99,205 104,165 Adjusted debt -35,555 -59,685 -55,462 -70,786 -87,964 Total capitalisation 153,075 179,619 217,741 242,022 268,174 Leverage Measures Debt/EBITDA -1.2x -1.9x -1.8x -2.0x -2.3x EBITDA/Interest expense 40.6x 36.1x 24.9x 27.7x 28.6x Gross debt/Capitalisation 41.4% 40.2% 43.4% 41.0% 38.8% FFO/Debt NM NM NM NM NM OCF/Debt NM NM NM NM NM FCF/Debt NM NM NM NM NM DCF/Debt NM NM NM NM NM Debt/Equity -39.6% -55.5% -45.0% -49.6% -53.6% FFO/Cash interest expense 36.8x 32.8x 22.5x 26.1x 27.2x NM - Not meaningful Sources: Company, Pengyuan International
Business Profiles
Home appliance giant and the leading market player in major appliances According to Euromonitor, Midea is the world’s largest air treatment brand and consumer appliances producer, in terms of volume. The Company ranked 307th in Fortune Global 500 in 2020, and ranked 35th in the Fortune China 500 in 2020. Midea reported a total revenue of RMB 279 billion in 2019. The Company has been the largest home appliance company in China in terms of revenue for sixth consecutive years. It is now leading by a sizeable amount with its revenue almost 40% higher than the next two major home appliance companies — Haier Smart Home and Gree Electric in 2019. In China, the three of them are head and shoulders above the rest in the industry.
Exhibit 3: Operating Scale and Growth of Selected Chinese Home Appliance Companies
300,000 20%
250,000 15%
200,000 10% 150,000 5%
100,000 (Revenue (Revenue in mil) 0% 50,000
0 -5% Midea Haier Smart Gree Electric Hisense Meiling Robam Homa Revenue Revenue 2year CAGR
Sources: Company, Pengyuan International
Among the selected six top Chinese home appliance firms, only Haier Smart Home and Gree Electric register higher two-year compound annual growth rate (CAGR) than Midea. Internationally, the three major non-China listed white-goods-focused companies – Johnson Control, Daikin industries and Whirlpool Corp – respectively have a translated revenue of RMB165 billion, RMB150 billion and RMB141 billion; the international trios are smaller than the big three in China by a significant amount. Moreover, these international firms, with the exception of Daikin, tend to have low revenue growth: Johnson Control, Whirlpool Corp, Carrier Electrolux registered a two-year CAGR range of -10.9% to 2.2% in 2019. Judging by the Company’s current scale and historical growth, Midea should maintain its status as the largest home appliance company in the world in the foreseeable future.
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Exhibit 4: Comparison of Midea Retail Sales Data between 2017, 2019 Midea’s Retail Sales Market Share and Rankings 2017 2019 2019 Rankings
Offline Channels Residential Air Conditioners 24.6% 28.9% 2 Laundry Appliances 24.6% 27.4% 2 Refrigerators 10.7% 12.6% 2 Rice Cookers 44.8% 43.9% 1 Electric Pressure Cookers 47.7% 44.3% 1 Induction Cookers 52.5% 48.5% 1 Electric Fans 45.0% 39.3% 1 Gas water Heaters 11.4% 11.6% 2 Water Purifiers 23.1% 22.2% 2 Countertop Microwave Ovens 45.3% 44.5% 2 Electric Water Heaters 19.6% 20.7% 3 Range Hoods 8.5% 8.7% 4
Online Channels Residential Air Conditioners 24.0% 30.0% 1 Commercial Air Conditioners N.A. 50.0% 1 Laundry Appliances 29.0% 31.2% 2 Refrigerators 15.0% 17.7% 2 Microwave ovens N.A. 53.0% 1 Pressure Cookers N.A. 41.0% 1 Rice Cookers 33.0% 29.6% 1 Electric Ovens 21.0% 22.7% 1 Induction Cookers 42.0% 39.0% 1 Electric Water Heaters 34.0% 30.6% 1 Gas Water Heaters 21.0% 18.0% 1 Electric Kettles 25.0% 23.0% 1 Electric Fans N.A. 19.2% 1 Vacuum Cleaners N.A. 10.3% 2 Water Dispensers 30.0% 18.9% 2 Water Purifiers 12.0% 13.1% 2 Dishwashers N.A 24.6% 2 Range Hood +Stove Suites 17.0% 10.4% 4
Sources: China Household Electric Appliance Research Association, National Household Electrical Appliance Industry Information Center, Midea, Pengyuan International
As shown in Exhibit 4, the Company has undoubtedly a strong market position among all white goods operators, with most of its product rankings either in the first or second place. Midea’s market share in major appliances has mostly increased over the past few years. Its residential air-conditioners, in particular, saw a relatively large expansion in all channels, online market share and an offline market share increased to 30% and 29% from 25% and 24%. Notably, the Company is also the world's largest home appliance core components manufacturer. According to GMCC-Welling’s website, one of every three air conditioners in the world is equipped with GMCC compressors and Welling motors, both of the brands are operated under Midea.
Exhibit 5: Global Sales of Residential Air Conditioners by Volume in 2019
AUX TCL Haier 7% 5% Hisense 7% 4% Meiling 2% Chigo 1% Others 13% Midea LG Other 3% 24% 28%
Daikin 3%
Mitsubishi Panasonic Electric Gree 3% 3% 25%
Sources: Chinaiol, Pengyuan International
According to the left-hand side pie chart of Exhibit 5, the top six global residential air-conditioner companies are all based in China. Clearly, Chinese firms have a dominant position in the home appliance industry. Midea’s air-conditioning sales ranked second globally by volume in 2019, just behind Gree. Notably, in first half of 2020, Midea outpaced Gree to be the world’s
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largest air-conditioner producer. In our view, this is due to Midea’s stronger online presence, and the Company is taking advantage of the increasing online purchasing behaviour, especially amid the full swing of the coronavirus pandemic. Judging from Exhibit 4, the Company has stronger presence in online channels than offline channels, and the Company has been the best-selling home appliance manufacturer on major e-commerce platforms in China for eight consecutive years. Last but not least, Midea, Haier Smart and Gree all have spent vastly more investments than other competitors in research and development. Midea is able to maintain a strong market share and become the top player within the industry because of its strong brand name and the maintenance of good product quality through research and development. To sum up, Midea is the largest home appliance company, not just in China but also in the world. The firm has very strong market share at least domestically, and has strong market share in a lot of major appliance product categories. However, this is partially offset by the fact that the home appliance industry is competitive and there is a large number of strong domestic and international rivals competing with Midea for every revenue.
Strong and diverse operations with high efficiency The Company mainly focuses on the manufacturing of heating, ventilation and air conditioning (HVAC), consumer appliances, and robotics and automation (R&A) systems, which together account for 91% of the revenue in FY2019. The remaining balance includes non-manufacturing revenue and other operating revenue related mostly to logistics and sales of materials. Contribution proportion from non-manufacturing revenue and other operating revenue have remained virtually unchanged for the last three years.
Exhibit 6: Revenue breakdown by business segment (2019)
Consumer Appliances 39% Other operating Revenue R&A Systems 8% 9%
Other 9%
non-manufacturing Revenue 1%
HVAC 43%
Sources: Company, Pengyuan International
In approximately equal proportions, HVAC and consumer appliances segment contribute nearly 90% of the Company’s profits in FY2019. Midea has a strong portfolio of products that covers all types of major appliances and some small appliances at multiple price levels, allowing the Company to capture growth from different opportunities and regions. Below is some of the brand names that the Company owns for the residential market:
Exhibit 7: Brand Portfolio of Midea's Residential Products HVAC brands High-end Clivet Mass Midea, Comfee, Toshiba Consumer Appliance High-end COLMO, Beverly, Eureka, Cuchen Mass Midea, Comfee, Little Swan, Bugu, Toshiba, WAHIN, Caffitaly Source: Pengyuan International
Besides the brand names above, the Company also has other brands for commercial business, such as MDV, GMCC and Welling. These brands have distinctive strategies with different market positions. Clearly, very few home appliance business operators have the diversified capabilities as Midea, as most of Midea’s peers have a focus on a few home appliance products, in our view.
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Exhibit 8: Geographical Revenue Breakdown of Selected Top Firms in FY2019
100%
80%
Overseas 60% Mainland China
40%
20%
0% Midea Haier Gree
Sources: Company, Pengyuan International
As a Chinese home appliance manufacturer, Midea has a very strong international presence, and it is one of the most geographically diverse home appliance companies in China. Only a few major appliance companies, such as Haier, Daikin and Electrolux have more geographically diverse operations. The Company now has operations in more than 200 countries and regions including but not limited to: North America, South America, Europe, Japan, Africa, India, Egypt, and most countries in Southeast Asia.
Exhibit 9: Gross Profit Margin by Location Exhibit 10: Cost Efficiency Comparison
35% 80% Midea 70% Chinese Peers' Median 30% International Peers' Median 60% 25% 50% 20% 40% 15% 30% 10% Mainland China 20% 5% Overseas 10%
- 0% 2014 2015 2016 2017 2018 2019 Cost of sales % SG&A %
Sources: Company, Bloomberg, Wind, Pengyuan International
Although the Company’s overseas business has relatively low gross margins, causing a contraction in Midea’s overall gross margin, the Company is still one of the most cost-efficient companies within the industry. Its cost of sales margin is marginally higher than all of the six selected domestic peers, with the exception of Robam. On the other hand, the Company’s selling, general and administrative (SG&A) expense as a percentage of revenue is slightly better than the median of both of its Chinese and international peers. The Company’s lower gross margin in overseas regions is partially because the Company distributes its products in the form of original design manufacturing (ODM) and original equipment manufacturing (OEM) to a lot of overseas markets. As the Company adapts more to an original brand manufacturing (OBM) business model, and improving its margins in its robotics and automation systems’ business, the Company will potentially continue to improve its profitability. In addition, the Company is showing very strong cost control and is already one of the most profitable in the industry.
Exhibit 11: Working Capital Efficiency Comparison
140 Midea 120 China Peers' Median 100 International Peers' Median 80 60 40 20 0 Receivable days Inventory days Payable days Cash conversion cycle Sources: Company, Bloomberg, Wind, Pengyuan International
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Midea is also showing very strong efficiency in its working capital management when compared to top-tier international and Chinese home appliance companies. Midea has overall higher turnover in receivables and payables, and its cash conversion cycle is better than its domestic and international peers. To sum up, the Company has strong business diversity. Unlike most home appliance companies, Midea deeply involves in all major appliance businesses, and provides a wide array of products that covers from high-end to low-end, and residential to commercial segments. Midea also has strong involvements in the key segments in the supply chain, including research and development, manufacturing, logistics and installation. On top of that, Midea is able to have very high efficiency on cost and working capital management. Considering the diversity on products and service it offers, its geographical presence, and its involvement in the supply chain, Midea is clearly one of the most diversified and most efficiently operated companies within the industry. Financial Profile
Long track records of above-industry growth with low volatility margins Buoyed by a few major acquisitions, the Company achieved strong growth in FY2016 and FY2017. Revenue growth slowed down afterwards and stayed mostly flat in FY2018 and FY2019, then decreased by 23% in the first quarter of 2020. The Company showed great recovery in the second and third quarter of 2020, minimising revenue contraction to 1.9%. The Company’s growth, from 2016 onward, has been generally stronger and more stable than the industry’s growth. According to China Household Electric Appliance Research Institute, domestic retail sales registered year-on-year growth from home appliances of 1.0%, -2.1%, -18.4% in 2018, 2019, 1H2020, and growth of total sales (including exports) at 9.9%, -25.7%, - 9.1% in the same period. Midea was less affected by the US-China trade war than most of its peers in the industry. During the pandemic, Midea was able to find opportunities through online channels, with online sales reported over 30% of growth in FY2019. Looking forward, we expect Midea to have continued its recovery in the fourth quarter, with 0% growth projected for the full fiscal year of 2020. Its revenue and EBITDA growth is expected to be slightly above 10% in FY2021, as the Company is already showing over 15% growth in the third quarter of 2020.
Exhibit 12: Midea’s Long Track Records of Above-Industry Growth with Low Volatility Margins 2015 2016 2017 2018 2019 1H2020 Revenue growth -2.3% 14.9% 51.3% 7.9% 7.1% -9.6% EBIT growth 13.7% 16.2% 18.6% 12.2% 11.0% -10.7%
Appliance manufacturing revenue growth -2.1% 14.7% 51.4% 8.2% 6.7% -9.8% Appliance segment profit growth -28.4% 88.3% 14.3% 27.7% 17.2% -16.8% Sources: Company, Pengyuan International
Midea’s operations are exceptionally stable. Even when under the impact of coronavirus pandemic, there is minimal volatility in both its gross and EBITDA margins. Gross margin has shown slight improvement since the acquisitions in FY2017 until the outbreak of the pandemic, whereas adjusted EBITDA margin, when excluding irregular gains and losses, was relatively flat. The selling and distribution expense made up 14.2%, 15.7% of revenue in FY2017 and FY2018, respectively, and has increased to 15.9% in FY2019, largely offsetting the improvements in gross margin. As gross margins suffer due to the pandemic in 2020, the Company has lowered sales and distribution expenses to 12.2% in the three quarters of 2020, showing great adaptability in challenging situations.
Exhibit 13: Gross and Adjusted EBITDA margin Exhibit 14: Revenue and EBITDA growth Gross Margin Revenue yoy Growth 35% 15% Adjusted EBITDA Margin Adjusted EBITDA Growth 30% 10% 25% 5% 20% 0% 15% 2018 2019 1H2020 2020 2021 2022 10% -5%
5% -10% 0% 2017 2018 2019 1H2020 2020 2021 2022 -15%
Sources: Company, Pengyuan International Sources: Company, Pengyuan International
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The disclosed cost breakdown for the home appliance segment is shown in Exhibit 15. The decreased in Midea’s gross margin can be partly explained by the increase in key commodity prices. The pandemic has disrupted the production of these commodities and caused the production cost of home appliance products to increase. According to our research, a lot of major appliance products have started to increase their retail prices in the second half of 2020 in a knee-jerk response to the increased commodity prices. We expect this will allow companies to recover from the gross margin contraction.
Exhibit 15: Cost Breakdown on Appliance Segment Exhibit 16: Price Index on Key commodity products in China
180 1Jan2016=100
Labor; 6% 160 Stanles Depreciation; 2% s Steel 140 Energy; 1% Plastic Others; 5% 120 Copper
Raw 100 Materials; 86% 80 Jan-16 Jan-17 Jan-18 Jan-19 Jan-20 Jan-21
Sources: Company, Wind, Pengyuan International Sources: Company, Wind, Pengyuan International
The Company has shown solid growth over the past few years while maintaining very stable margins. The Company’s margins have shown great resilience during the pandemic and even after several acquisitions was made – some of which were incurring losses at the time of acquisition. We expect the Company to maintain stable margins in the future and achieve higher- than-industry growth. Strong leverage profile and strong cash flow generating capability The Company increased its total debt by 14% in FY2019 and another 31% in the six months of 2020. However, looking at the table of Exhibit 17, debt to EBITDA ratios improved in both 2019 and 2020, mainly driven by a further decrease in the adjusted net cash.
Exhibit 17: Key Leverage Ratios Based on Adjusted Figures) Leverage Ratios 2018A 2019A 2020E 2021F 2022F Net Debt to EBITDA -1.2x -1.9x -1.8x -2.0x -2.3x EBITDA Interest Coverage 40.6x 36.1x 24.9x 27.7x 28.6x Gross Debt/ Total Capitalisation 41.4% 40.2% 43.4% 41.0% 38.8% FFO/Net Debt NM NM NM NM NM Source: Pengyuan International Midea has reported a net cash position for at least the last five years, and since FY2017, the Company’s net cash balance has been increasing despite rising total debt, as chart shown below. Adjusted net cash of Midea has increased because cash balance was increasing at a faster rate than gross debt. Midea has been able to gain cash and enhance its net cash position by 1) having strong cash inflow from operations, and 2) investing in short-term financial assets.
Exhibit 18: Total Debt and Adjusted Net Debt Progression Since 2016
150 Reported Total Debt Adjusted Net Debt
100
50
0
in RMB in billion RMB 2016 2017 2018 2019 1H2020 2020 2021 2022
-50
-100
Sources: Company, Pengyuan International
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Amid a low interest rate environment, a number of businesses increased their borrowings even though there is a shortage in capital. In no exception, Midea also increased its borrowings by 14% in FY2019 and another 31% in the six months of 2020. The proceeds from the borrowings increased mostly the cash balance and financial assets of the Company. Total financial assets increased by 31% and 24% in FY2019 and the six months of 2020, respectively. Total financial assets accounted for 40% of the Company’s total assets in 1H2020.
Exhibit 19: Higher Debt to Increase Cash Balance and Financial Assets
200 Reported Total Debt Total Financial Assets Financial Assets/Total Debt 200% 180 180% 160 160% 140 140% 120 120% 100 100%
80 80% RMB in RMBin billion 60 60% 40 40% 20 20% 0 0% 2017 2018 2019 1H2020 2020 2021 2022
Sources: Company, Pengyuan International
The current capital structure allows the Company to have an abundant amount of liquidity. With a massive cash and financial asset balance of RMB180 billion in the third quarter of 2020, the Company arguably has adequate capital to acquire some of the largest home appliance businesses in the world. In addition to the already completed Hiconics acquisition in 2020, it is likely to see more significant acquisitions in the near future, with potentially a slight increase in its shares buyback or dividend payout, in our view.
Exhibit 20: Midea’s Capital Structure Versus Peers Company's Debt/Capitalization Chinese Peers' D/C ratio 70% 70% Intl' Peers' D/C ratio 60% 60%
50% 50%
40% 40%
30% 30%
20% 20%
10% 10%
0% 0% 2016 2017 2018 2019 2020 2021 2022 Min Median Average Max
Sources: Midea, Wind, Pengyuan International
As shown in Exhibit 20, the Company maintained its debt to capitalisation (D/C) ratio at roughly at the same level since 2017. Excluding outliers, selected Chinese home-appliance peers have a D/C range from 28.4%-64.3%. The D/C level of Midea lies within home appliance peer’s D/C range, and aligns with peers’ average. Overall, the pandemic and the low interest rate environment prompted the Company to increase its borrowings in both FY2019 and FY2020. While it has been increasing its debt capital substantially over the past 24 months, the Company’s capital structure does not seem to be out-of-line to its peers, and arguably its current leverage ratios do not differ a lot from their historical levels. Looking forward, we expect the Company to continue to show net cash position and maintain a very strong leverage profile. Liquidity
Midea is cash rich and has a record of high liquidity. The Company reported RMB132.2 billion and RMB143.5 billion in cash and short-term investments in FY2019 and 1H2020. These figures are significantly higher than the RMB880 million and RMB950 million in financial expenses reported in the same period.
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The Company has demonstrated strong bargaining power against its supply chain stakeholders, showing working capital inflow for most years. Midea is able to drag both trade and non-trade payables, when receivables and inventory increases. However, in FY2020, we expect working capital changes to be negative, as Company’s non-trade payables did not increase as much as previous years. Short-term debt amounted to RMB11.6 billion, and accounted for 60% of the Company’s total debt in 1H2020. This amount is relatively small compared to the Company’s cash balance and short-term investments of RMB143.5, and should not constitute significant pressure on the Company’s ability to repay its debt. Overall, the Company has healthy liquidity ratios and these ratios have shown very little downside volatility. Given the Company’s strong balance sheet, and its strong and stable operating record, there is a lack of reasons to believe that the Company will run into any liquidity problems. The current ratio was 0.90x in FY2019 and was decreased to 0.86x in 1H2020. The quick ratio was improved from 0.67x to 0.70x in FY2019 and 1H2020. The Company has arguably maintained the same amount of liquidity before and after the pandemic. Without any substantial and unexpected changes, the Company should have no liquidity issues in the near future. We made the following key projections on Midea’s liquidity: • Estimated liquid assets on hand of RMB150.343 billion and RMB169.166 billion in 2020 and 2021; • Estimated FFO of RMB28.12 and RMB32.903 billion in 2020 and 2021; • Estimated short-term debt payment of RMB56.689 billion and RMB59.523 billion in 2020 and 2021; • Estimated cash interest of RMB1.25 billion and RMB1.259 billion in 2020 and 2021; • Estimated capital expenditure, excluding M&A spending, of RMB4.774 billion and RMB5.552 billion in 2020 and 2021. Company Background
Founded in 1968 and headquartered in Guangdong, Midea Group Co., Ltd., through its subsidiaries, mainly engages in the production and distribution of HVAC, and consumer appliances which primarily include refrigerators, laundry appliances, kitchen appliances and small domestic appliances. It also provides different robotics and automation systems, including production, distribution and storing systems that can be used in various industries, including but not limited to renewable energy, food and beverage, textile, medical, and industrials. Midea also provides installation, maintenance and after-sale services. It offers its products under brand names: Midea, Little Swan, Toshiba, Clivet, Comfee, COLMO, Beverly, Eureka, Cuchen, Bugu, WAHIN, Caffitaly, MDV, Welling and GMCC and others. The Company has operations in more than 200 countries and regions. As of FY2019, the Company had 58% of revenue from the mainland China and the remaining balance was from the rest of the world. Midea is the world’s largest major appliance producer. According to Euromonitor, Midea is the world’s largest air treatment brand and consumer appliances producer, in terms of volume. The Company has leading market share in multiple categories in China. Notably, as of the first half of 2020, Midea has taken over Gree to become the world’s largest air-conditioner producer. The Company ranked 307th in “Fortune Global 500 list of 2020”. Peer comparison
A total of 6 local peers and 8 international peers are selected in our evaluation of Midea’s operations. Given Midea’s strong and diverse presence in both China and overseas, these peers are separated into two categories in terms of geographical location: Chinese peers and international peers. Each of the selected peers has significant involvement in home appliances. Those with businesses that highly involve small home appliances and consumer electronics, such as TCL electronics, Skyworth were excluded from the list. Our selected peers are brand owners of the majority of their produced products. Retailers, such as Suning, and pure ODMs are also excluded, as both of these categories are subject to a significant different business risk and tend to have drastic difference in margins and profitability. The following is a short description of the selected local peer companies: Haier Smart Home Co Ltd Formerly known as Qingdao Haier, Haier Smart Home researches, develops, manufactures and distributes air conditioners, refrigerators, freezers, small household electrical appliances, and other related products. Haier Smart Home markets its products domestically and internationally. In FY2019, overseas home appliances and smart home business, refrigerators, washing machines, air conditioners, air conditioners parts and leases and others accounted for 46.7%, 15.4%, 11.2%, 10.6%, 10.3%, and 5.9% of total revenue, respectively. In the same period, Haier Smart Home generated 46.9% of its revenue from overseas markets.
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Gree Electric Gree Electric manufactures and sells different types of air conditioners, which include windows, splits, floors, mobiles, and ceiling types. Gree Electric also produces electric fans, water dispensers, heaters, rice cookers, air purifiers, and other small home appliances. In FY2019, air conditioning and parts manufacturing, small household appliances, other household appliances and others accounted for 70.0%, 2.8%, 20.8%, and 6.4% of total revenue. In the same period, Gree generated 13.3% of its revenue from overseas markets. Hisense Home Appliances Group Formerly known as Hisense Kelon Electrical, Hisense Home Appliance Group researches, develops, manufactures and distributes refrigerators, air conditioners, freezers, and other equipment. In FY2019, air-conditioners, refrigerators, other electrical household appliances, others accounted for 43.7%, 43.1%, 8.7%, and 4.5% of total revenue, respectively. In the same period, Hisense generated 33.6% of its revenue from overseas markets.
Changhong Meiling Co.,Ltd. Changhong Meiling researches, develops, manufactures and distributes household appliances, which include mainly refrigerators and freezers, washing machines, air conditioners and other household appliances. In FY2019, ventilators, gas stoves, disinfecting dishwashers and others accounted for 52.6%, 23.8%, 7.2%, and 16.4% of total revenue. In the same period, Changhong Meiling generated 25.3% of its revenue from overseas markets. Hangzhou Robam Appliances Company Limited Hangzhou Robam researches, develops, manufactures and distributes household kitchen appliances. The Company's major products include range hoods, gas stoves, disinfection cabinets, electric pressure cookers, induction cookers, electric kettles and food processing machines. In FY2019, household refrigerators and freezers, air-conditioners, small home appliances plus kitchen and bath, and others accounted for 47.8%, 35.7%, 6.0%, and 10.5% of total revenue, respectively. In the same period, Robam generated 25.3% of its revenue from overseas markets. Guangdong Homa Appliances Company Limited Guangdong Homa researches, develops, manufactures and distributes refrigerators and related parts. In FY2019, 100% of Homa’s revenue is related to the selling of refrigerator products. In the same period, Homa generated 77.9% of its revenue from overseas markets.
Exhibit 21: Peer comparison table (ratios as of FY19) (RMB mn) Haier Gree Midea Hisense Meiling Robam Homa Smart Electric Financials Revenue 278,216 200,762 200,508 37,453 16,553 7,761 7,393 Revenue 2year CAGR 7.5% 10.1% 15.6% 5.8% -0.7% 5.2% 3.0% Gross Margin 30.7% 29.6% 28.4% 21.4% 18.7% 54.3% 25.5% R&D % of sales 3.5% 2.8% 2.9% 2.5% 2.0% 3.9% 3.4% EBITDA 31,815 14,598 30,559 1,729 394 1,766 685 EBITDA Margin 11.4% 7.4% 15.2% 4.6% 2.4% 22.8% 9.3% Return on assets (ROA) 9.8% 5.6% 10.3% 3.3% 0.6% 16.5% 4.8% Return on invested capital (ROIC) 18.0% 11.4% 24.4% 7.4% 1.6% 23.8% 11.4%
Cash Flow Measures Funds from operations (FFO) 28,876 5,206 19,385 1,679 284 998 788 Operating cash flows (OCF) 37,320 13,724 27,795 2,061 1,269 1,678 938 Free cash flow (FCF) 33,868 19,918 32,508 2,424 1,595 1,950 1,073 Discretionary cash flow (DCF) 23,693 22,176 45,142 2,837 1,671 2,709 1,073 Capital expenditure 3,452 (6,194) (4,713) (364) (326) (272) (135)
Balance Sheet Measures Cash and short-term investments 132,240 33,645 129,238 4,185 5,386 5,389 1,613 Total debt 72,123 57,472 43,703 7,726 4,997 603 4,598 Adjusted net debt (59,685) 23,827 (85,535) 3,541 (389) (4,786) 2,985 Equity 107,496 47,888 110,154 8,722 5,005 6,864 2,553 Total capitalisation 179,619 105,360 153,857 16,448 10,002 7,468 7,151
Leverage Measures Debt/EBITDA NM 1.7x NM 2.0x NM NM 4.4x EBITDA interest coverage 36.1x 8.3x 19.1x 576.1x 4.2x 3699.1x 2.8x Gross Debt/ Total Capitalisation 40.2% 54.5% 28.4% 47.0% 50.0% 8.1% 64.3% Debt/Equity -55.5% 49.8% -77.7% 40.6% -7.8% -69.7% 116.9% FFO/Debt NM 21.8% NM 47.4% NM NM 26.4% OCF/Debt NM 57.6% NM 58.2% NM NM 31.4% FCF/Debt NM 83.6% NM 68.5% NM NM 35.9% DCF/Debt NM 93.1% NM 80.1% NM NM 35.9% FFO/Cash interest expense 32.8 3.0 12.1 559.5x 3.0 2090.5x 3.2
Operating Efficiency Receivable days 25.0 45.9 73.1 74.2 80.6 90.2 98.7 Inventory days 57.3 66.3 56.0 40.0 49.3 138.1 51.2
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Payable days 73.3 156.6 129.4 93.5 88.4 179.9 107.3 Cash conversion cycle 9.0 -44.4 -0.2 20.8 41.6 48.4 42.5 Asset Turnover 1.0x 1.1x 0.8x 1.3x 1.1x 0.8x 0.8x Cost of sales % 69.3% 70.4% 71.6% 78.6% 81.3% 45.7% 74.5% SG&A % 15.9% 25.8% 11.0% 16.5% 15.7% 28.0% 12.4%
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Rating Scores Summary
Business Profile Strong Industry and Operation Risk Profile Strong Macroenvironment Risk Low
Financial Profile aa+ Preliminary Leverage Profile aa Cash Flow Variations Neutral Debt Structure and Financial Policy Neutral Financial Volatility Neutral Investments 0 notch Final Leverage Profile aa+ Profitability Strong
Indicative Credit Score (ICS) a
Adjustment Factors Corporate Structure and Governance Neutral Liquidity Strong Supplementary Analysis Neutral
Standalone Credit Profile (SACP) a
External Support Parental Support N/A Government Support N/A Issuer Credit Rating (ICR) A
Note: ratings mentioned in this report are unsolicited rating.
Related Criteria
General Corporate Rating Criteria (15 March 2018)
Financial Adjustments and Ratio Definitions (07 May 2018)
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