January 5, 2018 / 2:39 AM / 19 days ago

Fitch Upgrades Longfor to 'BBB'; Outlook Stable

(The following statement was released by the rating agency) HONG KONG/BEIJING, January 04 (Fitch) Fitch Ratings has upgraded China-based Longfor Properties Co. Ltd.'s Long-Term Issuer Default Rating (IDR), senior unsecured rating and the ratings on its outstanding notes to 'BBB' from 'BBB-'. The Outlook is Stable. A full list of rating actions is at the end of this commentary. The upgrade follows Longfor's improving business profile, continued financial stability and established operational record. Longfor became a top-10 domestic player in 2017 by contracted sales with diversification across more than 31 Tier 1, 2 and 3 cities (based on land bank) and clear home buyer product segmentation. We expect Longfor to continue increasing its recurring rental income from investment properties (IP), including shopping malls and rental apartments. Our forecast of Longfor's recurring EBITDA/gross interest will trend higher to 0.7x by 2019, from 0.49x in 2016; a highly defensive quality among investment-grade peers in China's homebuilding space. Longfor's business profile has improved without compromising its leverage, which Fitch sees as evidence of a well-implemented growth strategy. Longfor's falling funding costs, to levels similar to even 'BBB+' grade peers, has also increased its financial flexibility. KEY RATING DRIVERS Established and Diversified Homebuilder: Longfor has built a diversified pan-China homebuilding business that covers more than 31 Tier 1, 2 and 3 cities (based on land bank) as well as clear home buyer product segmentation. The company has a firm foothold in western China, with a strong brand name in cities such as Chongqing and Chengdu. It had 50 million square metres (sq m) of gross land bank with an estimated land reserve life of five years at end-June 2017, with the Pan-Bohai Rim region accounting for 39% and western China 27%. Longfor generated strong sales growth of 85% in 11M17 with higher average selling price (ASP) of CNY15,247 per sq m, up 6% from 2016, despite its exposure to higher-tier cities that face stringent home purchase restriction policies. The company's move to replenish its land bank before the jump in land prices in 2016 has supported contracted sales growth and improved profitability. Fitch expects Longfor's sales growth to slow to 16% in 2018 because of the continued home purchase restrictions. The company's healthy land bank will allow it to slow land acquisitions and this will result in an improving financial profile if sales growth slows dramatically due to further policy tightening. Recurring Rental Income Foundation: Fitch expects Longfor to continue generating positive cash flow from operations (CFO) in 2017 and 2018, extending a trend that started in 2012. Longfor plans to aggressively expand its IP portfolio to boost recurring income in the long term using strong cash flow generation from its homebuilding business. It had 26 malls in operation in 2017, which had a 96% occupancy rate and generated gross rental income of CNY1.1 billion in 1H17 (last 12 months gross rental yield at cost: 6%). It plans to have more than 40 malls by end-2020. Longfor's rental apartment business launched in 1H17 and generated gross rental income of CNY3 million. Longfor aims to increase this to over CNY2 billion per year by 2020 through the operation of 100,000 rooms. Strong Operational Profile: We expect Longfor's operational profile to continue strengthening. Gross contracted sales amounted to CNY148 billion in first eleven months of 2017 (2016: CNY88 billion, 2015: CNY54 billion), significantly above Fitch's forecast. We expect Longfor's recurring gross rental income to rise by roughly 30% in 2017F to around CNY2.5 billion as new shopping malls start to ramp-up and we see positive rental reversion for Longfor's older shopping malls. Total contracted sales/total debt should jump to 2.0x in 2017, from 1.5x in 2016, and remain at that level for 2018F-2019F, indicating high churn compared with some similarly rated peers. Healthy Financial Position: Fitch expects Longfor's leverage - as measured by net debt/adjusted inventory, including IP valued at higher of cost or 5% yield - to be roughly 31% in 2017F, increasing to 33% in 2018F and 36% in 2019F. The higher leverage is likely to come from increased IP investments to boost long-term recurring income. Longfor's property development business scale has expanded substantially, requiring a larger working capital base. We believe the higher leverage should be manageable as Longfor has previously shown strong leverage discipline and management plans to control leverage, for example, by destocking inventory rather than acquiring more land. In addition, we believe higher leverage is the natural course of business during the expansion phase, as evidenced by the almost doubling of contracted sales yoy in 2017. We expect IP capex to peak in 2019 and for Longfor to deleverage from 2020. Room to Further Deleverage: Longfor's shopping malls are specifically targeted at China's middle class. With China's expanding economy and growing middle class, there are opportunities for positive rental reversions for its malls (mostly located in Tier 1 cities), which could lead to an increase in the fair value of Longfor's IP assets as assessed by an independent third party based on present and forecast rental yields. An increase in the value of its IP portfolio would increase the asset base supporting its indebtedness and result in a lower leverage. Low-Cost Funding Access: Longfor has ready access to diversified funding sources, including domestic and offshore bond markets and banks with its average cost of borrowing falling to 4.7% in 1H17, from 6.7% in 2012. Fitch expects Longfor's interest costs to remain low, as management is focused on maintaining ample liquidity, which helps support its ratings. Longfor recently issued five-year senior notes of USD450 million in the international capital market at a coupon rate of 3.875% per annum in July 2017. Coverage ratios, including recurring EBITDA/gross interest, are likely to further improve if Longfor's average funding costs continue to trend down. DERIVATION SUMMARY Fitch upgraded Longfor's IDR to reflect its strong operational performance, with contracted sales reaching critical mass, rising recurring income from IP and a healthy financial profile. Longfor has had stable and positive CFO since 2012 and we expect continued positive CFO, which in turn will support the gradual expansion of its homebuilding and IP businesses. We have compared Longfor to large-scale homebuilding peers rated 'BBB-' (Shimao Property Holdings Limited and Country Garden Holdings Co. Ltd.) and 'BBB+' (China Vanke Co., Ltd., China Resources Land Ltd (CR Land) and Poly Real Estate Group Company Limited). Poly's standalone credit profile is assessed at 'BBB'. We believe the one-notch difference against the 'BBB+' category peers is justified, as Longfor has higher leverage, as measured by net debt/adjusted inventory, than Vanke and CR Land, but lower leverage than Poly. Longfor has stronger recurring EBITDA/gross interest than Vanke, though its ratio is comparable with that of Poly and weaker than that of CR Land. Longfor's EBITDA margins are similar to that of Poly, but stronger than those of Vanke and CR Land. Vanke has stronger sales efficiency than Longfor, while that of CR Land and Poly are weaker. We also believe the one-notch difference against the 'BBB-' peers is justified as Longfor has stronger recurring EBITDA/gross interest than both peers, while its EBITDA margin is higher than that of Country Garden and comparable with that of Shimao. Longfor's leverage is higher than that of both peers, but its sales efficiency is stronger than that of Shimao and comparable with that of Country Garden. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: - Gross contracted sales to increase by 16% yoy in 2018 and 2019 (2016: 62%, 2017: 76%) - EBITDA margin of around 23%-27% in 2018-2019 (2016: 23%, 2017 estimate: 28.7%) - IP income from shopping malls to reach CNY3.2 billion in 2018 and CNY4.2 billion in 2019 - IP income from rental apartments to reach CNY0.6 billion in 2018 and CNY1.2 billion in 2019 RATING SENSITIVITIES Developments that May, Individually or Collectively, Lead to Positive Rating Action - Net debt/adjusted inventory (investment property valued at higher of cost or 5% yield) sustained below 30% - IP expanding in scale to generate substantially higher recurring income Developments that May, Individually or Collectively, Lead to Negative Rating Action - Net debt/adjusted inventory (investment property valued at higher of cost or 5% yield) above 40% for a sustained period - Contracted sales/total debt below 1.5x for a sustained period - EBITDA margin below 22% for a sustained period - Weakening of cash flow from operations for a sustained period LIQUIDITY Diversified Funding Sources: Longfor has diversified funding channels, including offshore and onshore bonds, offshore and onshore bank loans and funds. The funding sources help lower refinancing risk and provide capital to operate the business when market liquidity is tight. Longfor has established long-term strategic relationships with onshore and offshore banks. Sufficient Liquidity: Longfor had CNY22.6 billion of cash at end-June 2017, sufficient to cover short-term debt of CNY7.7 billion. The company has made opportunistic early repayments for most of its US dollar debt financing. Fitch expects the group to maintain sufficient liquidity to fund development costs, land premium payments and debt obligations during 2018-2019 due to its diversified funding channels and flexible land acquisition strategy. FULL LIST OF RATING ACTIONS Longfor Properties Co. Ltd. Long-Term IDR upgraded to 'BBB' from 'BBB-'; Outlook Stable Foreign-currency senior unsecured rating upgraded to 'BBB' from 'BBB-' USD500 million 6.75% senior unsecured notes due 2023 upgraded to 'BBB' from 'BBB-' USD450 million 3.875% senior unsecured notes due 2022 upgraded to 'BBB' from 'BBB-' CNY2 billion 6.75% senior unsecured notes due 2018 upgraded to 'BBB' from 'BBB-' Contact: Primary Analyst Andrew Shingfun Chan Director +852 2263 9559 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. 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