Credit FAQ:

China's Department Stores Face An Uphill Battle As Competition Intensifies And Economic Growth Slows
Primary Credit Analyst: Lillian Chiou, Hong Kong (852) 2533-3530; lillian.chiou@standardandpoors.com Secondary Contacts: Bei Fu, Hong Kong (852) 2533-3512; bei.fu@standardandpoors.com Joe Poon, Hong Kong (852) 2533-3507; joe.poon@standardandpoors.com

Table Of Contents
Frequently Asked Questions Related Criteria And Research

WWW.STANDARDANDPOORS.COM/RATINGSDIRECT

APRIL 22, 2014 1

1301287 | 301447691

Credit FAQ:

China's Department Stores Face An Uphill Battle As Competition Intensifies And Economic Growth Slows
On April 15, Standard & Poor's Ratings Services lowered its long-term corporate credit rating on Parkson Retail Group Ltd. to 'BB-' following a downgrade of the company to 'BB' from 'BB+' on Feb. 21, 2014. (See "Parkson Retail Group Ltd. Rating Lowered To 'BB-' On Weakening Financial Performance; Outlook Stable," published April 15, 2014, on RatingsDirect on the Global Credit Portal.) The double downgrade comes amid increasingly gloomy revenue prospects for China's department store sector over the next 12-24 months, with retail sales growth decelerating and competition intensifying. Total retail sales of consumer goods in China grew by just 13.1% in 2013, the slowest rate since 2005, while growth in department store sales dropped to 10.3%, from 12.6% in 2012. This compares unfavorably with gains in online retail sales of 31.9% in 2013. Below, we answer some frequently asked questions about the prospects for China's department store sector and its credit trends.

Frequently Asked Questions

What has made Parkson the lowest rated Chinese department store operator despite its well-established domestic store portfolio?
Parkson's performance has deteriorated over the past two years, and in 2013 it posted its worst performance since the company went public nine years ago. We expect no improvements in the next 12 months given the company's weak operating efficiency and aggressive expansion plans through accelerated expansion of new stores. Unfortunately, this comes as Chinese economic growth is slowing, and the government's program against extravagance and corruption eats into sales of luxury goods. We expect Parkson's weak financial performance to persist amid weak consumer sentiment and rapidly rising costs. The company is particularly vulnerable to higher rents because of its large portfolio of leased stores. We believe Parkson faces challenges in increasing property ownership, a practice adopted by its rated domestic peers, namely Golden Eagle Retail Group Ltd., Intime Retail (Group) Co. Ltd., and Maoye International Holdings Ltd. In our opinion, the ability to develop property gives the company's peers an advantage in accessing high-quality properties at reasonable costs, while Parkson must bid for or acquire properties at market rates. With commercial property values rising substantially, we expect Parkson's owned-store space to remain at a low of about 15% over the next couple of years, in contrast with its peers' average of 64% as of end-2013. Historically, Parkson's established store portfolio has provided stable recurring income, but more recently has impeded the company's ability to adapt to new industry trends. Parkson's stores have become less appealing to consumers in

WWW.STANDARDANDPOORS.COM/RATINGSDIRECT

APRIL 22, 2014 2

1301287 | 301447691

Credit FAQ: China's Department Stores Face An Uphill Battle As Competition Intensifies And Economic Growth Slows

recent years as rivals have moved toward larger floor space and increased their lifestyle-experience offering to fend off competition from e-commerce rivals.

Can Parkson return to growth and profitability?

We believe Parkson is running out of steam in terms of growth and profit in the near term. As one of the earliest players in the sector, Parkson benefited from high industry growth and was able to achieve large profits through leasing store premises. The company's strategy in the past was to lock in prime locations in every major city in China through long leases. We considered this strategy as logical and successful in the past, and we still view Parkson's geographic diversity as better than that of its peers. In addition, Parkson has established its brand name in China through sophisticated and professional store management methods. Given the ample and low-cost supply of commercial properties in the early days, Parkson's asset-light strategy enabled the company to expand rapidly to become one of the country's largest department store operators. However, competition has intensified in recent years as newcomers, including real-estate developers, have flooded the market. In our opinion, Parkson's geographic diversity has not achieved critical mass, but commercial properties in prime locations have become harder to obtain and rents are rising rapidly. It is now expensive for Parkson to sustain its asset-light expansion strategy. In addition, domestic department store operators have adapted to modern management techniques, and are able to present their stores in formats that are attractive to customers. Moreover, the company is eager to establish a strong presence in regional markets in China as its rated domestic peers have done. Parkson is losing market share to its domestic rivals as it tries to play catch-up, while its weaker regional position has reduced its bargaining power with suppliers. That said, Parkson's long-term strategy is in line with industry trends and could help the company reclaim its leading position in terms of operating results. Parkson now mainly targets opening stores in lower tier cities and locations where it already has a presence. The company has first mover advantage in this respect. As China pushes forward with its urbanization program, we believe the purchasing power of some lower tier cities will increase, as was the case in tier one cities 10-15 years ago. The company is actively seeking opportunities to increase store ownership. This strategy, if executed well and fast enough, could help Parkson improve its bargaining power with suppliers and better control operating costs, especially rents. Strategy execution over the next two years is likely to be a key issue in determining whether a turnaround is likely.

Is Parkson well positioned against online retailers?

Parkson has no clear strategy in e-commerce or to compete with online retailers, in our opinion. To counter strong competition from e-commerce retailers, traditional department stores need to shift toward open lifestyle type shopping malls which are more likely to attract greater customer flows. Some are actively embracing online platforms and tools and developing online-to-offline (O2O) business. However, Parkson has been slow to adjust its store format or form any strategy to attract attention from online shoppers and the company's accelerated store expansion might not be sufficient to compensate for sales lost to online retailers.

Are China's other rated department stores suffering similarly?

We believe China's three other rated department store operators are in better positions to face industry challenges and fend off competition, both offline or online. They have higher levels of store ownership than Parkson and a stronger

WWW.STANDARDANDPOORS.COM/RATINGSDIRECT

APRIL 22, 2014 3

1301287 | 301447691

Credit FAQ: China's Department Stores Face An Uphill Battle As Competition Intensifies And Economic Growth Slows

regional presence and, therefore, in our view, better operating efficiency. Store ownership in good locations is a strength for these companies, insulating them from rising rents and fostering stable profitability. Commercial property development capabilities, some through sister companies, are also a positive factor. Such capabilities can secure prime locations at relatively low costs and build larger malls to compete with existing malls and the rise of e-commerce. In all of this, bargaining power is critical, helping retailers to ensure the supply of newer or more popular products, and to obtain better discounts. While geographic diversification is important, it is crucial that it does not come at the expense of bargaining power with regional suppliers. China's rated department store operators have no proven e-commerce strategies, in our opinion. However, Parkson's peers are more active in preparing for competition with online retailers and finding their own e-commerce solutions. Intime's recent collaboration with Alibaba to develop an online shopping platform could prove successful in the long term, though near-term results might be limited (see "Intime Retail (Group) Co. Ltd. Ratings And Outlook Unaffected By Alibaba Investment," published April 2, 2014).

How has the government's anti-extravagance and corruption program affected China's department store operators?
China's crackdown on corruption and extravagance has weighed on sales of luxury goods, a trend that has been exacerbated by the country's slowing economic growth. The impact is more pronounced for department store operators in tier one cities. We have noticed a clear slowdown in sales of traditional cash coupons and gift cards by rated department stores, pointing to a potential slowing of spending momentum. Furthermore, we have seen a change in consumer buying behavior. Those seeking high-priced items often find them from foreign retailers or in boutique shops, while those looking for lower-priced goods shop online or at specialty stores. According to tax-refund specialist Global Blue, Chinese spending on tax-free shopping rose by 20% in 2013, indicating strong buying abroad. Accordingly, department stores are in a difficult position and increasingly need to re-shuffle brands to attract in-store spending.

How much of a threat to department stores is e-commerce?

Online sales in China are expanding much faster than sales at bricks-and-mortar retailers. In 2013, online sales rose by 31.9%, compared with just 10.3% at department stores, 8.3% at supermarkets, and 7.5% at specialty stores. However, for luxury goods, consumers still appear to prefer to buy in-store, in part to avoid fake products and for the shopping experience. In such conditions, we expect Chinese department stores to move gradually away from the concessionaire model and to develop more proprietary brands, which carry higher margins. We expect many to shift away from stand-alone stores toward mixed-use integrated developments, and from purely retail outlets to provision of a more complete shopping experience. Specifically, department stores are transforming into larger, multi-functional venues that include, for example, restaurants and recreational facilities to attract customers. We expect increased collaboration between online and offline players and further development of O2O business. As yet, however, there is no successful model and we remain cautious about the expenses department stores might incur

WWW.STANDARDANDPOORS.COM/RATINGSDIRECT

APRIL 22, 2014 4

1301287 | 301447691

Credit FAQ: China's Department Stores Face An Uphill Battle As Competition Intensifies And Economic Growth Slows

through investment in their e-commerce strategies, particularly for marketing and promotions. Any inability to control costs effectively or protect margins could lead to major losses. In 2013, Chinese home-appliance retailer Suning Commerce Group Co. Ltd. expanded its O2O strategy aggressively, and net profit fell by more than 95% due to much lower margins resulting from online sales and heavy promotional costs. Although the business model of Suning is different from that of our rated department stores, it is still a good example how profitability could deteriorate dramatically without a profitable strategy.

What will define the credit profiles of China's department stores as the operating environment changes?
The sector is facing challenging operating conditions including slowing economic expansion, the government crackdown on extravagance and corruption, fierce industry competition, and the threat from e-commerce. The operating results of China's four rated department stores indicate broadly lower gross sales per square meter, same store sales, direct sales margins, and concessionaire rates over the past four years (see charts 1, 2, 3, and 4), suggesting generally tougher operating conditions over that period.
Chart 1

WWW.STANDARDANDPOORS.COM/RATINGSDIRECT

APRIL 22, 2014 5

1301287 | 301447691

Credit FAQ: China's Department Stores Face An Uphill Battle As Competition Intensifies And Economic Growth Slows

Chart 2

WWW.STANDARDANDPOORS.COM/RATINGSDIRECT

APRIL 22, 2014 6

1301287 | 301447691

Credit FAQ: China's Department Stores Face An Uphill Battle As Competition Intensifies And Economic Growth Slows

Chart 3

WWW.STANDARDANDPOORS.COM/RATINGSDIRECT

APRIL 22, 2014 7

1301287 | 301447691

Credit FAQ: China's Department Stores Face An Uphill Battle As Competition Intensifies And Economic Growth Slows

Chart 4

A lack of differentiation is likely to erode sales and profitability further. In some tier one cities, such as Shenzhen, about half the brands overlap with those offered by nearby department stores. Inability to offer popular products can also undermine earnings. We estimate that about 30% of the most popular products are in perpetual shortage. For this reason, some competitors elsewhere in the region can generate better growth, because of stronger bargaining power with regional suppliers. Direct sales could represent a key way to differentiate, but they create significant challenges in terms of working capital requirements and merchandise management. Store management and operating efficiency also affect profitability. As it stands, we see shrinking margins across the board, a condition more severe for companies with fewer self-owned properties. As the sector's performance weakens, we expect a polarization of rating trends. More agile players that can quickly adapt to change will likely become larger, while slower and inflexible companies could eventually exit the industry.

Related Criteria And Research

Related Research
Parkson Retail Group Ltd. Rating Lowered To 'BB-' On Weakening Financial Performance; Outlook Stable, April 15, 2014

WWW.STANDARDANDPOORS.COM/RATINGSDIRECT

APRIL 22, 2014 8

1301287 | 301447691

Credit FAQ: China's Department Stores Face An Uphill Battle As Competition Intensifies And Economic Growth Slows Intime Retail (Group) Co. Ltd. Ratings And Outlook Unaffected By Alibaba Investment, April 2, 2014 Parkson Retail Group Ltd. Rating Lowered To 'BB' And Placed On Watch Negative On Deteriorating Financial Performance, Feb. 21, 2014 Under Standard & Poor's policies, only a Rating Committee can determine a Credit Rating Action (including a Credit Rating change, affirmation or withdrawal, Rating Outlook change, or CreditWatch action). This commentary and its subject matter have not been the subject of Rating Committee action and should not be interpreted as a change to, or affirmation of, a Credit Rating or Rating Outlook.

WWW.STANDARDANDPOORS.COM/RATINGSDIRECT

APRIL 22, 2014 9

1301287 | 301447691

Copyright 2014 Standard & Poor's Financial Services LLC, a part of McGraw Hill Financial. All rights reserved. No content (including ratings, credit-related analyses and data, valuations, model, software or other application or output therefrom) or any part thereof (Content) may be modified, reverse engineered, reproduced or distributed in any form by any means, or stored in a database or retrieval system, without the prior written permission of Standard & Poor's Financial Services LLC or its affiliates (collectively, S&P). The Content shall not be used for any unlawful or unauthorized purposes. S&P and any third-party providers, as well as their directors, officers, shareholders, employees or agents (collectively S&P Parties) do not guarantee the accuracy, completeness, timeliness or availability of the Content. S&P Parties are not responsible for any errors or omissions (negligent or otherwise), regardless of the cause, for the results obtained from the use of the Content, or for the security or maintenance of any data input by the user. The Content is provided on an "as is" basis. S&P PARTIES DISCLAIM ANY AND ALL EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE, FREEDOM FROM BUGS, SOFTWARE ERRORS OR DEFECTS, THAT THE CONTENT'S FUNCTIONING WILL BE UNINTERRUPTED, OR THAT THE CONTENT WILL OPERATE WITH ANY SOFTWARE OR HARDWARE CONFIGURATION. In no event shall S&P Parties be liable to any party for any direct, indirect, incidental, exemplary, compensatory, punitive, special or consequential damages, costs, expenses, legal fees, or losses (including, without limitation, lost income or lost profits and opportunity costs or losses caused by negligence) in connection with any use of the Content even if advised of the possibility of such damages. Credit-related and other analyses, including ratings, and statements in the Content are statements of opinion as of the date they are expressed and not statements of fact. S&P's opinions, analyses, and rating acknowledgment decisions (described below) are not recommendations to purchase, hold, or sell any securities or to make any investment decisions, and do not address the suitability of any security. S&P assumes no obligation to update the Content following publication in any form or format. The Content should not be relied on and is not a substitute for the skill, judgment and experience of the user, its management, employees, advisors and/or clients when making investment and other business decisions. S&P does not act as a fiduciary or an investment advisor except where registered as such. While S&P has obtained information from sources it believes to be reliable, S&P does not perform an audit and undertakes no duty of due diligence or independent verification of any information it receives. To the extent that regulatory authorities allow a rating agency to acknowledge in one jurisdiction a rating issued in another jurisdiction for certain regulatory purposes, S&P reserves the right to assign, withdraw, or suspend such acknowledgement at any time and in its sole discretion. S&P Parties disclaim any duty whatsoever arising out of the assignment, withdrawal, or suspension of an acknowledgment as well as any liability for any damage alleged to have been suffered on account thereof. S&P keeps certain activities of its business units separate from each other in order to preserve the independence and objectivity of their respective activities. As a result, certain business units of S&P may have information that is not available to other S&P business units. S&P has established policies and procedures to maintain the confidentiality of certain nonpublic information received in connection with each analytical process. S&P may receive compensation for its ratings and certain analyses, normally from issuers or underwriters of securities or from obligors. S&P reserves the right to disseminate its opinions and analyses. S&P's public ratings and analyses are made available on its Web sites, www.standardandpoors.com (free of charge), and www.ratingsdirect.com and www.globalcreditportal.com (subscription) and www.spcapitaliq.com (subscription) and may be distributed through other means, including via S&P publications and third-party redistributors. Additional information about our ratings fees is available at www.standardandpoors.com/usratingsfees.

WWW.STANDARDANDPOORS.COM/RATINGSDIRECT

APRIL 22, 2014 10

1301287 | 301447691