August 4, 2017 / 1:56 AM / 7 months ago

Fitch Rates CNLP's USD Notes Final 'B'

(The following statement was released by the rating agency) HONG KONG/SHANGHAI, August 03 (Fitch) Fitch Ratings has assigned China Logistics Property Holdings Co., Ltd's (CNLP; B/Stable) USD100 million 8% senior notes due 2020 a final rating of 'B' and Recovery Rating of 'RR4'. The notes are rated at the same level as CNLP's senior unsecured rating because they constitute its direct and senior unsecured obligations. The final rating is in line with the expected rating assigned on 25 July 2017. CNLP's ratings are supported by the strong industry demand for high-standard warehouses, the company's national geographic coverage and its extensive network. CNLP will also benefit from its advantage in China's Yangtze River Delta (YRD) region, being one of the largest logistic-property owners in the area. However, its ratings are constrained by its small scale, low interest coverage of below 1.0x at 0.57x in 2016, and continuing funding demand for capex. CNLP's reliance on debt for this expansion indicates its limited financial flexibility, and is therefore a further constraint on its rating. KEY RATING DRIVERS Growing Industry, Regional Imbalance: China's high-standard warehouse industry is still underdeveloped. This presents enormous potential, as this type of space accounted for only 2%-3% of total warehouse supply of around 1 billion square metres (sqm) at end-2015 - in sharp contrast to a penetration rate of over 20% in the US. The industry has been growing rapidly over the past decade, driven by compound annual growth rate (CAGR) growth of over 40% in the e-commerce sector in 2011-2015. E-commerce (including related third-party logistics, or 3PLs) is likely to comprise 50% of the new warehouse demand in 2017, according to CBRE research. Nevertheless, the favourable industry outlook and higher investment return have attracted so many new entrants that some Tier 2 cities in China started to show signs of overcapacity in 2016, especially in western China such as Chengdu, Chongqing and Wuhan. On the other hand, Fitch expects Tier 1 city rents to hold firm and enjoy 3%-6% rent reversion due to limited land supply. We are likely to see rent divergence in different cities and some weakness in the rental growth of lower-tier cities in 2017. Strong Network Effect, YRD-Focused: CNLP is one of the top 10 high-standard warehouse owners in China, with more than 2 million sqm of completed logistic properties. CNLP is relatively stronger in the YRD, with 30%-40% completed gross floor area (GFA) concentrated in Zhejiang and Jiangsu provinces - of which Suzhou alone accounts for 20%-30%. is the largest customer and contributed 31% of CNLP's total revenue in 2016; 34% of the GFA completed is occupied by multi-location tenants. The market competition will continue to be intense, although Fitch believes that the industry will be increasingly dominated by large players with strong networks and solid customer relationships. Small Scale, Declining Occupancy Rate: CNLP had recurring EBITDA of USD17 million in 2016, much smaller than the industry leader Global Logistic Properties Limited's (BBB+/Stable) EBITDA USD772 million in the year ended March 2017. CNLP had a thin EBITDA margin of only 40% in 2016, due mainly to its small scale. The company is also facing a declining occupancy rate for its completed and 'stabilised' logistic assets, which dropped to 86.6% in 2016 from 97.3% in 2014. Judging by the relatively low occupancy rate of the 2016 new projects, Fitch expects the occupancy rate for stabilised assets to further decline in 2017, which will exert pressure on CNLP's EBITDA margin and pace of expansion. CNLP defines 'stabilised projects' as those in operation for more than 12 months or achieving a 90% occupancy rate. High Capex, Low Interest Coverage: CNLP's recurring EBITDA interest coverage was only 0.57x in 2016 (excluding all IPO-related expenses). Coverage may edge lower in 2017 because the interest payment will more than double after CNLP replaces all equity-like hybrid instruments with traditional debt funding, even if EBITDA doubles in 2017. Fitch expects coverage to rise to above 1x by end-2019 when more than 80% of CNLP's assets become stabilised. However, any significant changes in market demand/supply dynamics may delay the improvement in CNLP's interest coverage. Low Leverage: CNLP's LTV (net debt to investment property assets) was low at 26% at end 2016. However, Fitch expects the leverage headroom to be small as CNLP's unsecured assets/unsecured debt coverage was only 1.1x and will continue to hover around 1x in the next three years. CNLP had CNY1.5 billion in unpledged investment property at end-2016, while unsecured offshore debt amounted to CNY1.4 billion. Recovery Rating of 'RR4': The Recovery Rating for CNLP's senior unsecured notes is based on its end-2016 balance sheet. We applied a haircut of 50% on its net property, plant and equipment (including investment properties) of CNY12.8 billion. The adjusted liquidation value, after administrative claims, is CNY5.8 billion and is first applied to CNY3.2 billion in onshore debt, then to the CNY4.1 billion in offshore unsecured debt, including a potential USD300 million of outstanding senior unsecured notes, resulting in a 62% recovery rate, which corresponds to a Recovery Rating of 'RR3'. However, CNLP's Recovery Rating is capped at 'RR4' because debt of offshore Chinese holding companies face structural issues as the onshore operating companies do not provide upstream guarantees. DERIVATION SUMMARY CNLP's business profile is in line with the 'B+'/'BB-' category, but the recurring EBITDA interest coverage of only 0.6x is more in line with a 'B-' rating, which results in a final rating of 'B'. CNLP is still far away from 'BB-' rated peers such as Lai Fung Holdings Limited (BB-/Stable), which has interest coverage of 1.3x and better asset quality; and PT Pakuwon Jati Tbk (BB-/Positive), which has an interest coverage of 2.5x, helped by its quality malls but constrained by its small scale and exposure to development property. CNLP's financials are weaker than PT Kawasan Industri Jababeka Tbk (KJIA, B+/Stable), whose recurring EBITDA is generated from its long-term electricity sales and purchase agreements with state-owned PT Perusahaan Listrik Negara (PLN, BBB-/Positive), and the interest coverage hovers consistently above 1x with temporary disruption due to power plant repair work. However, CNLP is expanding faster than KIJA, driven by demand from China's fast-growing e-commerce industry. Fitch expects CNLP's financial profile to be closer to a 'B' rating in 2019-2020, depending on market conditions and the ramp-up of progress in CNLP's new projects. CNLP's weaker financial profile than other investment-property owners is also due to the logistic property sector's longer return period and CNLP's fast expansion. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: - Completed and stabilised assets-occupancy rate to edge down to 86% in 2017-2018 due to a lower occupancy rate for pre-stabilised assets. - Effective rent growth of 2% in 2017-2018. - Total completed net leasable area of 2.6 million sqm and 3.5 million sqm in 2017-2018. - EBITDA margin to improve to 49% in 2017 and 59% in 2018. RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to Positive Rating Action - Stable occupancy rate for completed and stabilised assets above 80% - Recurring EBITDA/interest coverage sustained above 1.2x - Net debt/recurring EBITDA sustained below 10x (2016: 27.8x) Future Developments That May, Individually or Collectively, Lead to Negative Rating Action - Recurring EBITDA/interest coverage fails to improve significantly - Inability to secure funding for expansion or deterioration in liquidity - Weakening of business profile that would be reflected in a significant drop in occupancy rates or a sustained fall in rentals LIQUIDITY Weak Liquidity: CNLP had about CNY2 billion in cash equivalents as of end-2016 compared with CNY604 million of short-term debt. Liquidity is bolstered by CNY3 billion of equity proceeds from its IPO in June 2016. However, Fitch expects CNLP to rely on capital market debt, further equity placements, or to sell land to fund its CNY2 billion-3 billion capex per year over the next three years. Contact: Primary Analyst Winnie Guo Associate Director +852 2263 9969 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 Date of Relevant Rating Committee: 22 June 2017 Media Relations: Wai-Lun Wan, Hong Kong, Tel: +852 2263 9935, Email: Additional information is available on Applicable Criteria Country-Specific Treatment of Recovery Ratings (pub. 18 Oct 2016) here Criteria for Rating Non-Financial Corporates (pub. 10 Mar 2017) here Non-Financial Corporates Hybrids Treatment and Notching Criteria (pub. 27 Apr 2017) here Non-Financial Corporates Notching and Recovery Ratings Criteria (pub. 16 Jun 2017) here Additional Disclosures Solicitation Status here#solicitation Endorsement Policy here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. 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