OREANDA-NEWS. Fitch Ratings, Hong Kong, 28 April 2015: Fitch Ratings has affirmed China Vanke Co., Ltd's (Vanke) Long-Term Foreign-Currency and Local-Currency Issuer Default Ratings (IDR) at 'BBB+'. The Outlook is Stable. Fitch has also affirmed the Chinese homebuilder's foreign-currency and local-currency senior unsecured ratings at 'BBB+'.

The notes issued by Bestgain Real Estate Limited and Bestgain Real Estate Lyra Limited are also affirmed at 'BBB+'. These notes are jointly and severally guaranteed by Vanke Real Estate (Hong Kong) Company Ltd (Vanke HK), a wholly owned subsidiary of Vanke.

The affirmation reflects Vanke's delivery of strong contracted sales of CNY215.130bn in 2014 while maintaining strong focus on the mass market. However, its EBITDA margins weakened to 22%. It continued to retain its market leadership due to its strong operational and execution abilities and it maintained sufficient liquidity.

KEY RATINGS DRIVERS

Improved Financial Strength: Vanke continues to deliver superior asset churn, with the ratio of contracted sales to total debt at 2.94x at end-2014 and 2.09x at end-2013. However, this came at the expense of lower EBITDA margins, which fell to 22.0% at end-2014 from 24.9% at end-2013. Fitch expects Vanke to continue its high turnover model, with the ratio of contracted sales to total debt continuing to be above 2x, and does not expect substantial improvement in the company's margins for the next 24 months. The high asset turnover in 2014 reduced Vanke's inventory, though whether this impacts the stock of homes for sale in 2015 will depend on the company's acquisition strategy for the year. Vanke aimed to preserve cash and improve cash flow given the weaker market conditions in 2014; as a result its leverage position has improved at end-2014. Vanke's adjusted inventory fell 4.5% to CNY314.9bn at end-2014 while the ratio of contracted sales to adjusted inventory increased to 0.96x at end-2014 from 0.71x at end-2013.

Sales Growth to Slow: Vanke's contracted sales have increased strongly at a three-year compound annual growth rate (CAGR) of 27%-36% between 2007 to 2012, but slowed to 16.5% in 2013 and 20.9% in 2014. Fitch expects Vanke's growth in contracted sales to slow due to more intense competition and a larger base effect. Three-year CAGR for contracted sales is likely to be 15%-25% in the short to medium term. The average selling price (ASP) for contracted sales increased 4% to CNY11,909 per square metre (sqm) in 2014. It cash collection rate hit 90.2% at end-2014 from 86% at end-2013.

National Coverage and Large Scale: Vanke is the largest homebuilder in China's residential market by contracted sales. It has over 400 projects for sale in more than 61 cities, of which over two-thirds are in Tier 1 and 2 cities. Its land bank of 38.09m sqm in gross floor area (GFA) is well-diversified and is one of the largest in China. Vanke's market share has increased to 2.82% at end-2014 from 2.05% at end-2010. The large scale provides Vanke with operational and financial flexibility. It has also moved towards using prefabricated building components to ensure quality, quick replication, lower cost and standardisation.

Focus on Mass Market: Vanke continued to focus on the mass-market segment in 2014, with units smaller than 144 sqm accounting for around 90% of its residential units in 2014. This allowed Vanke to continue to meet demand from China's urbanisation trend and maintain its large scale and market leadership. By focusing on the mass-market segment, Vanke achieved CAGR of 28% for contract sales from 2009 to 2014 despite strict home purchase restrictions imposed in Tier 1 and some major Tier 2 cities in China.

Higher Funding Cost: Vanke's average funding cost in 2014 was 7%-8%, higher than the 3%-6% for other Chinese homebuilders rated in the 'BBB' category (those rated 'BBB-', 'BBB' and 'BBB+'), which are mostly state-owned enterprises. Vanke is privately owned and does not have that advantage. To improve its funding cost and capital structure, Vanke issued a 2.625% USD800m five-year offshore bond and set up a USD2bn multi-currency medium-term note program in 2013 and issued SGD140m of 3.275% four-year bonds, CNY1bn of 4.5% five-year bonds denominated in offshore yuan, CNY1bn of 4.05% three-year bonds in offshore yuan, and USD400m of 4.50% five-year bonds in 2014.

Outlook Stable: Fitch expects that Vanke will maintain its leadership in the Chinese residential homebuilding market, with a clear focus on first-time homebuyers and upgraders. Vanke will use its operational and financial flexibility and continue to grow at a moderate pace in the highly competitive and cyclical Chinese property market.

KEY ASSUMPTIONS

Fitch's key assumptions within our rating case for the issuer include:
- Contracted sales by gross floor area to increase by 0%-10% over 2015-2017;
- Average selling price for contracted sales to increase by 0%-2% for 2015-2017;
- EBITDA margin of around 18%-19% in 2015-2017

RATING SENSITIVITIES:

Negative: Future developments that may, individually or collectively, lead to negative rating action include:
- Unfavourable changes to China's regulation or economy leading to a decline in contracted sales; or 
- Decline in EBITDA margin to below 20% (2014: 22%); or 
- Increase in net debt/adjusted inventory to above 30% over a sustained period (2014: 3.5%)
- Contracted sales/total debt remaining below 1.75x over a sustained period (2014: 2.9x)
- Deviation from its current focus on mass-market housing

Positive: Positive rating action is not expected over the next 12 to 18 months due to the high cyclicality as well as the high regulatory risks in the Chinese property sector.