OREANDA-NEWS. Fitch Ratings has affirmed China-based Yuexiu Property Company Limited's (YXP) Long-Term Issuer Default Rating (IDR) at 'BBB-'. The Outlook is Stable. Fitch has also affirmed YXP's senior unsecured rating at 'BBB-'.

The affirmation is premised on YXP's strong market position in Guangzhou, increasing focus on high asset churn model and its moderate leverage level, which has partially mitigated the company's weaker profitability arising from projects outside Guangzhou.

KEY RATING DRIVERS

Support from Government: YXP's ratings benefit from a one-notch uplift due to its moderately strong linkage with the Guangzhou State-owned Assets Supervision and Administration Commission (SASAC). YXP's partnership with other state-owned enterprises in Guangzhou via an investment fund also demonstrates the support that its parent Guangzhou Yuexiu Group and the Guangzhou government provide to help the company acquire quality land parcels.

Improving Asset Churn: YXP's contracted sales increased 51% to CNY22bn in 2014 (2013: CNY14.6bn) as it sped up its project turnaround and projects outside Guangzhou started to contribute to sales. In 2014, contracted sales/total debt improved to 0.67x from 0.60x in 2013. Fitch expects the company's gradual improvement in asset churn to partially offset weaker profitability stemming from the soft pricing environment.

Dominant in Guangzhou: YXP remained among the top three property developers in Guangzhou in terms of contracted sales in 2014. The company's strong reputation and market position in Guangzhou and its quality land bank, in which sites in the more prosperous Pearl River Delta Region account for 50%, will continue to support its sales over the medium term.

Favourable JV Structure: YXP began acquiring land jointly with an investment fund, which was set up by state-owned enterprises in Guangzhou and managed by Guangzhou Yuexiu Group. Under the partnership, YXP has the option to buy shares it does not already own in the projects 12-24 months after the original land purchase, with a premium that would provide existing partners an internal rate of return of 11%-12% a year. This allows YXP to acquire the project if it sells well. The project risk is reduced given the better sales visibility and the shorter development cycle, but such projects have lower profit margins because YXP will be booking them at revalued prices. YXP's downside risk is limited because it has no obligation to exercise the option on projects with poor sales.

Leverage to Remain Stable: YXP's net debt/adjusted inventory was stable at 36% in 2014 (2013: 34%) as it slowed land replenishment and successfully raised HKD3.85bn via a rights issue in 4Q14. YXP has set a moderate sales growth target of around 10% in 2015 and remains selective on land acquisitions following its rapid growth in the past two years. The company would also be able to leverage on project acquisitions from the investment fund to support its scale. With no new large investment property projects other than those currently under development, YXP's leverage would likely stay around 40% in 2015.

Margin Weaker Outside Guangzhou: YXP's EBITDA margin fell to 17.3% from 20.1% in 2013 following increasing contribution from lower-margin projects outside Guangzhou, weaker average selling prices amid a slower market and costlier land costs from stiffer competition. YXP's long-term profitability is likely to stabilise in the high teens, albeit at a lower level than before, buffered by its quality land bank that has resilient demand.

Recurring Income Less Significant: As YXP's property development segment expanded, recurring income became a less significant part of total income. Recurring EBITDA interest coverage fell to 0.2x in 2014 (2013: 0.34x) as rental revenue was affected by tenant changes at Guangzhou Fortune World Plaza. Fitch expects recurring EBITDA interest coverage to stay at around 0.20x over the next 12-24 months until the tenant mix in Guangzhou Fortune World Plaza stabilises and Yuexiu Financial Tower opens in 2016.

KEY ASSUMPTIONS

Fitch's key assumptions within our rating case for the issuer include:
- Contracted sales to increase by high single digits over 2015-2017;
- Average selling price for contracted sales to increase by 3% per year for 2015-2017;
- Fitch estimates the gross profit margin at around 23% -25% in 2015-2017 (2014: 26%)

RATING SENSITIVITIES

Positive: Positive rating action is not expected over the next 12-18 months because of YXP's still small recurring EBITDA interest coverage and lower asset turnover compared to peers.
Nonetheless, future developments that may, individually or collectively, lead to positive rating action include:
- Evidence of stronger linkage with the Guangzhou government
- Recurring EBITDA interest coverage improving to above 1.0x together with recurring EBITDA above CNY1bn (2014: CNY350m)
- Sustained improvement of contracted sales/ total debt to closer to 1x

Negative: Future developments that may, individually or collectively, lead to negative rating action include-
- Weakened linkage with the Guangzhou government
- Weakened financial profile of Guangzhou Yuexiu Group leading to YXP having to provide support to its parent
- Net debt/adjusted inventory (not including REIT assets) exceeding 45%
- Contracted sales / total debt sustained below 0.60x
- Significant drop in contracted sales.