Fitch Ratings has revised the Outlook on China-based S.F. Holding Co., Ltd.'s (SF) Long-Term Issuer Default Rating (IDR) to Stable, from Negative, and affirmed the Long-Term IDR at 'A-'.

SF's senior unsecured rating and the ratings on its outstanding bonds have also been affirmed at 'A-'. A full list of rating actions is listed below.

The Outlook revision reflects the company's recovery in profitability and deleveraging capacity following its acquisition of Kerry Logistics Network Limited (KLN) in September 2021. Higher operating efficiency at SF's businesses, the contribution from KLN and our expectation of lower capital intensity should allow free cash flow (FCF) to trend towards neutral or positive, from negative, after the growth-related investments in 2021.

The rating affirmation reflects SF's strong business profile as China's leading express-delivery service company. The company's expansion into diversified logistics services, such as freight and cold-chain delivery, also provides high visibility on growth in new segments, which is supported by the KLN acquisition.

Key Rating Drivers

Deleveraging Capacity: We expects SF's leverage to remain below 2x net adjusted debt/EBITDAR in the medium term. Improved profitability after the KLN acquisition, lower capex and equity share placement proceeds of CNY19.9 billion in 2021 should allow leverage to remain stable or drop gradually. SF may make occasional growth investments, but they are likely to be smaller than its enlarged business scale, contributing to our expectation of neutral-to-positive FCF starting 2022 and resulting in sufficient rating headroom for SF.

Controlled Capex: We estimate capital intensity will be controlled at around 6%, compared with 8%-9% in 2020-2021, since its incremental investments to pursue growth opportunities and continuously improve operations should be lower than its enlarged revenue base. In addition, SF's proportion of committed capex is not high and can be flexibly reduced, depending on market conditions.

Improved Profitability: We think SF can sustain the progress it has made in improving profitability over the past year, despite a challenging economic environment. Profitability has risen yoy since 4Q21 to an EBITDA margin of around 6.9% in 1H22, from 5.6% in 2021, in spite of the impact of Covid-19 pandemic control measures in China, notably in 2Q22. This is reinforced by its positive profit alert for 3Q22. An improvement beyond our expectations would strengthen SF's financial profile, as current profitability is still below the historical range of 9%-10%.

Higher Operating Efficiency: The profitability of SF's newer businesses, apart from express delivery, should improve with greater economies of scale. Segments such as heavy load, and supply chain and international are at breakeven or have turned to net profit in 1H22, from a net loss in 1H21. Business diversification has improved; we estimate half of revenue will be from non-express delivery businesses in 2022, compared with less than 30% before 2020. The consolidation of KLN has boosted diversification, with synergies leading to incremental profit.

Better Pricing: We expect SF's traditional express delivery business to see stable-to-higher pricing ability after easing competitive pressure. Pricing for the China express delivery industry has been under continuous pressure for the past few years, but we think it is approaching a floor where marginal cost savings from economies of scale are diminishing. In 2021, regulators stepped in to warn or fine price disruptors and protect courier benefits, which should reduce below-cost pricing. SF's average selling price (ASP) has mostly been flat or rising yoy since November 2021.

Premium Position Maintained: We expect SF to keep its position at the higher end of the market. Direct model operators, such as SF, tend to have a higher revenue share instead of volume, compared with partner-model companies, which focus on e-tailing deliveries that face constant price pressure from fierce competition. SF's ASP per parcel of around CNY16 has been consistently higher than the CNY2-3 of peers.

Derivation Summary

SF has a strong business profile as the market leader in China's express-delivery service sector. The closest global peer in the express and logistics-service industry is Deutsche Post AG (DP; BBB+/Positive). SF has lower diversification in terms of express and logistics-service contribution and smaller scale than DP, but a much higher parcel volume capacity and stronger growth profile. SF's financial profile historically compared favourably with DP's due to lower adjusted net debt/EBITDAR, but profitability may be volatile as SF invests in newer businesses.

Key Assumptions

Fitch's Key Assumptions Within Our Rating Case for the Issuer

Revenue growth of 31% in 2022 (based on yoy reported growth following partial year consolidation of KLN in 2021), before moderating to 5% by 2024

EBITDA margin of 7% in 2021, before improving to 8% by 2023-2024 (2021: 5.6%)

Capital intensity of 6% in 2021-2024 (2021: 9.3%)

Dividend payout maintained at 20% in 2021-2023, in line with historical level

Cash outflow of CNY5 billion in 2022-2023, primarily for KLN's announced acquisitions, including future contingent obligations

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to positive rating action/upgrade:

No positive rating action is envisaged until the company significantly diversifies its product and geographical markets without compromising its profit margin or financial profile

Factors that could, individually or collectively, lead to negative rating action/downgrade:

Sustained decline in EBITDA

Adjusted net debt/EBITDAR above 2.0x (2022 forecast: 1.7x) and/or FFO adjusted net leverage sustained above 2.3x (2022 forecast: 1.9x)

Persistent negative FCF, stemming from high capital intensity, which, for instance, is not sustainably covered by non-debt sources

Significant loss of express-delivery service market share or lower-than-industry average growth

Best/Worst Case Rating Scenario

International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.

Liquidity and Debt Structure

Adequate Liquidity: SF has a strong balance sheet, with around CNY48 billion in cash and cash equivalents as of end-June 2022, which is more than sufficient to cover its short-term debt obligations of about CNY20 billion. In addition, the company has access to available banking facilities of around CNY60 billion as of end-June 2022.

Issuer Profile

SF is a leading express delivery and integrated logistics service provider. It is the market leader in China's express delivery industry by value and its delivery network offers nationwide coverage. It also has supply chain operations, including through KLN.

Summary of Financial Adjustments

Fitch has chosen to use the multiple approach to capitalise leases for SF, assessing leverage on an adjusted basis. We think the multiple approach is more appropriate for express delivery companies like SF under Fitch's Generic Ratings Navigator as the decision to lease or buy key operating assets is a core financial decision among major players and adjusted metrics would allow for better comparability.

Fitch-defined lease expenses have been capitalised using a 6x multiple, representing Fitch's estimate of the useful economic life of the main assets.

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

ESG Considerations

Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg

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