June 28, 2017 / 8:48 AM / 3 months ago

Fitch Rates Evergrande's USD Notes Final 'B-'

(The following statement was released by the rating agency) HONG KONG, June 28 (Fitch) Fitch Ratings has assigned China Evergrande Group's (B+/Stable) USD598 million 6.25% senior notes due 2021, USD1.3 billion 7.5% senior notes due 2023 and USD4.7 billion 8.75% senior notes due 2025 a final 'B-' rating, with a Recovery Rating of 'RR6'. The proposed notes are rated at the same level as Evergrande's senior unsecured rating as they constitute direct and senior unsecured obligations. The proceeds will be used to refinance debt and general corporate purposes. The final rating is in line with the expected rating assigned on 21 June 2017. KEY RATING DRIVERS Improved Debt Structure: Evergrande's leverage and payables-to-gross inventory ratio has been improving further in 2017. This had been on an upward trend since 2010, but stabilised in 2016. The improvements came in as a result of its strong contracted sales growth, redemption of most perpetual debt in 1H17, and also receiving the full proceeds from its CNY70 billion equity-raising for its onshore subsidiary from new investors. Fitch will review its 1H17 result to assess the impact of the improvement. Stronger Land Bank Profile: Evergrande has shifted its sales away from lower-tier cities, reducing risks to sales and profitability. The company's land bank has swung sharply to Tier 1 and 2 cities, with these two categories making up 74.7% of its land bank by value and 57.9% by gross floor area at end-2016. Contracted sales from Tier 1 and 2 cities accounted for 67.4% of total sales in 2016, compared with 59% in 2015. Evergrande's average selling price (ASP) is still rising, and reached CNY10,269 per square metre (sq m) in May 2017 and CNY9,786 per sq m in the first five months in 2017 from CNY8,355 in 2016. Large Interest Burden: Evergrande's gross interest expense and distributions to holders of perpetual capital instruments in 2016 totalled CNY42.3 billion, a jump from CNY25.4 billion in 2015. Evergrande's gross interest expense exceeded capitalised interest for the first time. Interest expenses as a proportion of contracted sales improved to 11.3% from 12.5% in 2015, although the improvement is much smaller if an adjustment for Evergrande's cheaper funding cost in 2016 is included. We believe that Evergrande's high expenditure will continue to limit its operating cash flow generation and limit its ability to deleverage meaningfully. Shareholder-Friendly Moves Pressure Credit: Evergrande has bought back shares totalling HKD6.3 billion (CNY5.6 billion) since 29 March 2017, after its 2016 results announcement. Evergrande also plans to make a dividend payment of 50% of profit of 2016 and 1H17, only after it successfully lists its onshore property operation in China's A-share market, despite sustaining high negative FCF before dividend. This puts creditors at a disadvantage as the company is not building up a healthy buffer to improve its financial flexibility. DERIVATION SUMMARY Evergrande's business profile is more reflective of that of 'BB' category peers as Evergrande has a diversified geographical and product profile. This offsets its very aggressive financial profile, which is comparable with that of companies in the weak 'B' category. Its peers, like Country Garden Holdings Co. Ltd. (BB+/Stable), Greenland Holding Group Company Limited (BB+/Negative) and Sunac China Holdings Limited (BB/Negative), are similarly aggressive in expanding their scale and are among the 10 largest Chinese homebuilders. Country Garden's leverage of around 30% and churn rate of over 1.5x, is commensurate with a high 'BB' category profile and explains the multiple notch rating gap between it and Evergrande. Greenland's leverage is as high as that of Evergrande but Greenland has a large level of uncollected sales to mitigate its high leverage. Greenland, as a state-owned enterprise, has a stronger position in acquiring land at low costs, especially for new city districts that local governments are keen to develop. This enhances Greenland's business profile over that of Evergrande. Sunac's leverage is low at between 40%-50% and it does not have high payables risks, unlike Evergrande. Sunac's sales are also mostly in major cities and is reflected by its higher ASP of CNY20,480 per sq m, more than double that of Evergrande. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: - large homebuilders continue to win market share, which supports Evergrande's aim to increase sales by 15% to 25% between 2017 and 2019 - ASP in 2017 to match 1Q17 level and continue to climb at around 3%-5% thereafter, with higher-tier cities making up a larger share of sales - land acquisition volume to stay at 120% of the gross floor area sold in the same year - trade payables and receivables to grow in line with contracted sales growth RATING SENSITIVITIES Developments That May, Individually or Collectively, Lead to Positive Rating Action - Net debt/adjusted inventory sustained below 50% (59% in 2016) - Contracted sales/gross debt sustained above 0.8x (0.57x in 2016) - EBITDA margin sustained above 18% (16.5% in 2016) Developments That May, Individually or Collectively, Lead to Negative Rating Action - Net debt/adjusted inventory sustained above 60% - Total payables/gross inventory sustained above 0.45x (0.42x in 2016) - Tighter liquidity position due to weaker access to financing channels LIQUIDITY Large Liquidity Gives Flexibility: Evergrande has continued to maintain a large cash balance totalling CNY304 billion, including CNY106 billion of restricted cash, and CNY138 billion of available undrawn but uncommitted facilities to meet its debt servicing and operation needs. This was higher than CNY164 billion in total cash (CNY61 billion restricted) and CNY155 billion in facilities in 2015. The company also issued USD2.5 billion of senior notes in 1Q17 to refinance its existing debt. 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 Winnie Guo Associate Director +852 2263 9969 Committee Chairperson Kalai Pillay Senior Director +65 6796 7221 Date of Relevant Rating Committee: 24 April 2017 Summary of Financial Statement Adjustments - - Perpetual capital instruments of CNY113 billion are treated as debt - Financial assets (both long-term and short-term) are adjusted at 40% and included in available cash Media Relations: Leslie Tan, Singapore, Tel: +65 67 96 7234, Email: leslie.tan@fitchratings.com; Wai-Lun Wan, Hong Kong, Tel: +852 2263 9935, Email: wailun.wan@fitchratings.com. 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