May 29, 2017 / 8:14 AM / 2 months ago

Fitch Affirms Redco at 'B'; Outlook Stable

14 Min Read

(The following statement was released by the rating agency) HONG KONG/SHANGHAI, May 29 (Fitch) Fitch Ratings has affirmed China-based Redco Properties Group Ltd's (Redco) Long-Term Foreign-Currency Issuer Default Rating (IDR) at 'B' with Stable Outlook. The agency has also affirmed Redco's senior unsecured rating and the rating on its USD125 million 13.75% senior notes due 2019 at 'B' with Recovery Rating of 'RR4'. Redco's ratings are affirmed as it has maintained a healthy financial profile - its leverage, as measured by net debt/adjusted inventory, including proportionate consolidation of joint ventures (JVs), was low at 7.4% at end-2016 and its EBITDA margin was 14.8%. However, Redco's slow land replenishment has caused its available-for-sale land bank to drop to only around two years' worth of sales. Its limited land bank will start to pose a threat to the sustainability of Redco's business profile amid the company's transition to a fast-churn business model. In Fitch's view, a low level of land reserves will likely reduce Redco's land acquisition flexibility and expose the company to financial volatility during market weakness. Fitch will consider positive rating action if Redco is able to sustainably increase its scale and land bank without significantly compromising its leverage. KEY RATING DRIVERS Transition to Fast-Churn Model: Fitch believes Redco is transitioning to a fast-churn model, which will lead to faster sales turnover but relatively lower margins. Redco's full-year contracted sales (including JVs) increased 150% to CNY10 billion in 2016 and grew more than 21% to CNY1.9 billion in 1Q17. Redco's sales efficiency, measured by contracted sales/total debt, improved significantly, rising to 2.8x in 2016 from 1.3x in 2015. At the same time, Redco's 2016 EBITDA margin fell to 15%, due to lower gross profit margins for the Sunshine Coast phase 1 project in Yantai. Management expects Redco to further expand sales to CNY14 billion in 2017 and CNY20 billion in 2018. Limited Land Bank Constrains Rating: Redco had a land bank of around 3.5 million square metres (sq m) as of end-2016. Nanchang, Tianjin and Jinan accounted for 65%-70% of Redco's land bank by gross floor area (GFA) and value as of end-2016. The three cities will continue to be Redco's key markets and are likely to contribute around 60% of sales in 2017. However, Fitch estimates that the portion of Redco's land bank that is available for sale (saleable GFA that the company owns) is around CNY27 billion, which is only sufficient for two years of contracted sales. Redco intends to maintain a small land bank as part of the company's strategy to keep leverage under control. We believe that Redco will be able to secure sufficient land for property development in 2017-2018 and that keeping a small land bank is beneficial to its financial profile. However, compared to peers with sufficient land reserves, Redco has less land acquisition flexibility and is more susceptible to land price and supply volatility, which will result in a volatile financial profile. Expansion to Drive up Leverage: Fitch estimates Redco will need more land to sustain its attributable sales above CNY8 billion, the level at which Fitch may consider positive rating action, given its change to a fast-churn business model. Net debt/adjusted inventory (including JV proportionate consolidation) was kept low at 7.4% in 2016 (2015: 15.2%) because of faster sales and controlled land banking. However, assuming Redco spends 70% of its sales receipts in 2017-2020 to replenish its land bank, leverage will approach 35% in 2017 and 45% in 2018, in line with that of 'B' rated credits. Any efforts to significantly increase its land bank will push the leverage above those levels. DERIVATION SUMMARY Redco's CNY10 billion contracted sales in 2016 are comparable with 'B' rated companies such as Xinyuan Real Estate Co., Ltd. (B/Stable) with CNY12 billion and Xinhu Zhongbao Co., Ltd. (B/Stable) with CNY16 billion. Although Redco's leverage is considered low among its peers, its land bank is smaller than those of most companies with a 'B' rating. Xinyuan also has the same constraint to its rating. Companies that are rated one notch above Redco, at 'B+', in general have proven sustainable business models with attributable sales of over CNY10 billion, larger land banks of more than three years' worth of development and stable leverage at around 40%. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: - Contracted sales including JVs reach CNY14 billion in 2017, CNY20 billion in 2018, CNY28 billion in 2019. - Gross profit margin from property development remaining below 25% in 2017-2020. - Land replenished at a rate of 1.3x of annual sales by gross floor area and land premium accounting for 65%-70% of annual sales receipts in 2017-2020. - Construction cost accounting for around 35% of annual sales receipts in 2017-2020. RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to Positive Rating Action - Annual attributable contracted sales sustained above CNY8 billion (2016: CNY7 billion) while maintaining available-for-sale land bank for 2.5 years of development (2016: 2 years) - Net debt/adjusted inventory sustained below 40% - EBITDA margin sustained above 20% (2016: 14.8%) Future Developments That May, Individually or Collectively, Lead to Negative Rating Action - Sustained drop in contracted sales - Net debt/ adjusted inventory sustained above 50% - EBITDA margin sustained below 15% LIQUIDITY Sufficient Liquidity: Redco had cash and cash equivalents of CNY3.6 billion (including restricted cash of CNY1.2 billion), and CNY876 million of undrawn bank facilities, which are sufficient to cover the company's short-term debt of CNY137 million. Contact: Primary Analyst Vicki Shen Director +852 2263 9918 Fitch (Hong Kong) Limited 19/F Man Yee Building 68 Des Voeux Road Central, Hong Kong Secondary Analyst Chloe He Associate Director +86 21 5097 3015 Committee Chairperson Su Aik Lim Senior Director +852 2263 9914 Media Relations: Wai-Lun Wan, Hong Kong, Tel: +852 2263 9935, Email: wailun.wan@fitchratings.com. Additional information is available on www.fitchratings.com Applicable Criteria Country-Specific Treatment of Recovery Ratings (pub. 18 Oct 2016) here Criteria for Rating Non-Financial Corporates (pub. 10 Mar 2017) here Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers (pub. 21 Nov 2016) here Additional Disclosures Dodd-Frank Rating Information Disclosure Form here Solicitation Status here#solicitation Endorsement Policy here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. 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