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March 14 (Reuters) - (The following statement was released by the rating agency)
Fitch Ratings has assigned China-based trade centre developer China South City Holdings Limited’s (CSC; B+/Positive) USD125m 13.5% senior notes due 2017 a rating of ‘B+’ and recovery rating of ‘RR4’. The notes are rated at the same level as CSC’s senior unsecured rating as they represent direct, unconditional, unsecured and unsubordinated obligations of the company.
Increasing Scale, Entry to More Cities: The Positive Outlook on CSC’s rating reflects the company’s increasing scale and geographic diversification as sales from newer projects start contributing meaningfully to its cash flows. CSC has been expanding into seven other provincial capital cities outside Shenzhen through collaborations with their provincial governments. CSC will be able to establish itself as a national provider of integrated trade centres if it is able to sustain its sales momentum - the company increased its contracted sales to HKD12.6bn in the first nine months of the financial year ending March 2014 (FY13: HKD8.2bn).
Good Project Locations with High Profitability: Following its start in Shenzhen in December 2004, the company has developed a track record of executing large-scale integrated trade centre developments and a strong reputation, which enables it to expand into locations of its choice. All of CSC’s projects are located in provincial capitals and its large acquired land resources of 18m square metres will support the company’s development plan for the next five to eight years. The company’s cooperation with provincial governments for its projects also lowers its land costs and contributed to its higher EBITDA margins (1H FY14: 39.2%) relative to its peers.
Moderate Leverage: CSC’s leverage is comparable to that at similarly rated peers in the mass-market homebuilding segment, despite lower asset churn with contracted sales/gross debt of 0.69x in FY13 and exposure to the investment property business, which has a long investment horizon. The recent HKD1.5bn new share issuance to Tencent Group also provides CSC additional financial and technical resources to expand its e-commerce platform. As CSC increases its scale, Fitch estimates the company’s ratio of net debt to adjusted inventory (investment property valued at cost) will increase to around 35% over the medium term (1H FY14: 30.6%), though this would still be comparable to levels seen at its peers.
Commercial Demand More Volatile: CSC’s rating is constrained by its exposure to more volatile commercial property demand. Its projects outside Shenzhen (4m sqm-18m sqm) are also of significantly larger scale than those in Shenzhen (2.6m sqm) and sales are still at initial phases, which exposes the company to considerable demand and execution risks. Competition from nearby projects may also create downward pressure on average selling prices (ASPs) and negatively impact the company’s profit margins. In Fitch’s view, CSC’s moderate leverage and completed properties in Shenzhen, valued at HKD14bn end-FY13, provide a financial buffer in the event of a downturn in demand.
Limited Geographical Diversification: While CSC has diversified out of Shenzhen by pre-selling projects in Nanchang, Nanning, Xian, Zhengzhou and Harbin in the past two years, only the Shenzhen project is currently in operation. The initial phases of its Nanchang, Nanning and Xian projects are slated to start operation in early 2014. Fitch views the ability to replicate its success in Shenzhen in these large-scale projects in Tier-2 cities to be important, particularly to sustain sales and ASPs of subsequent phases.
Low Yielding Investment Property Assets: CSC generally retains around 50% of the gross floor area of its trade centres for lease (FY13: 0.52m sqm consisting of Phase One and Phase Two in China South City Shenzhen) but for the medium-term, CSC will remain reliant on property sales for cash generation. Its investment property assets have long investment horizons: occupancy at China South City Shenzhen Phase 2 has only reached 60% after starting operation in 2010. Fitch expects the company’s recurring EBITDA to grow gradually but still remain small relative to its recurring EBITDA interest coverage, which would likely stay below 0.3x for the next three years.
Future developments that may, individually or collectively, lead to positive rating action include:-
- Ability to sustain sales outside Shenzhen without dominance by any one particular project (no more than 30% of total contracted sales), with total contracted sales sustained at above CNY12bn a year
- EBITDA margin sustained at above 40%
- Net debt/adjusted inventory sustained at below 35% (with investment property valued at cost)
- Contracted sales/gross debt sustained at above 1x
Failure to meet the above guidelines over the rating horizon would lead to the Outlook being revised to Stable.