OREANDA-NEWS. Fitch Ratings has upgraded China-based property developer Sunac China Holdings Limited's (Sunac) Long-Term Foreign-Currency Issuer Default Rating (IDR) and its senior unsecured rating to 'BB' from 'BB-'. The Outlook on the IDR is Stable. The full list of rating actions is at the end of this commentary.

The upgrade is supported by Fitch's view that Sunac's contracted sales of CNY40bn on attributable basis are sustainable, the company's low leverage and strong liquidity, its quality land bank, and its conservative expansion plan. Sunac's rating is mainly constrained by its current low margin as well as uncertainties about its strategy to acquire land by taking stakes in companies or projects.

KEY RATING DRIVERS

Increased Scale is Sustainable: Sunac's attributable contracted sales reached CNY39bn in 2014 and CNY19bn in 1H15. Fitch estimates its attributable contracted sales will exceed CNY40bn in 2015, based on its plans for project launches. This makes Sunac's scale by contracted sales larger than other 'BB-' rated Chinese homebuilders and comparable with those rated 'BB'. We expect the company's contracted sales to increase in single digits in the next one to two years, supported by the size and quality of its land bank.

Low Leverage, Strong Liquidity: Sunac's leverage, measured by net debt/adjusted inventory, was only 19% at end-2014. Leverage rose to 30% at end-1H15 after it acquired several projects from Greentown China Holdings and because it launched fewer projects in the first half of the year. A recent acquisition of seven projects in Chengdu as well as potential land purchases in 2H15 may further increase Sunac's leverage, but Fitch expects the ratio to remain under 40% as the agency expects cash flow from contracted sales to improve in 2H15. Sunac's cash position was CNY17bn at end-1H15, enough to cover its short-term debt of CNY12.5bn. The strong liquidity position also supports its future acquisition plans.

Conservative Expansion Plan: Sunac's business focus going forward will be on improving project profitability and securing bigger stakes joint ventures, instead of expanding its scale. It will not acquire land aggressively, but will maximise available opportunities to improve margins. Sunac's attributable land bank of 17.2m square metres as of August 2015 would be enough to support the expected increase in contracted sales. About 90% of the land bank is in Tier-1 and Tier-2 cities, which enjoy better demand and support stronger pricing.

Margin to Remain Subdued: Sunac's margins were lower in 1H15 mainly due to the weak market in 2014, and Fitch expects the margins to mildly recover in the next 12-18 month. The drop in EBITDA margin to 10% in 1H15 from 18% in 2014 is a result of the timing of project revenue recognised in its accounts. Sunac's margins in its financial statements are constantly at a low level, mainly due to the accounting impact from the fair-value reassessment when Sunac acquires its partners' shares in their joint projects. These projects are substantially sold and would not add much operational risk to Sunac in the future. Excluding the impact of re-valuation of the acquisitions, the gross margin is 24% in 2014, and 21% in 1H15.

The low level of revenue recognised in 1H15 also increased sales, general and administrative expenses (SG&A) as a percentage of revenue in EBITDA margin calculation. As there is no operation deterioration, this drop in the EBITDA margin is one-off and would not impact the ratings. Fitch expects full-year EBITDA margin to go back to the high-teens level with gradual improvement towards 20% going forward, but still low compared with its peers. However, Sunac's financial profile is supported by its financial flexibility given its strong liquidity position, low leverage and land bank quality.

Land Banking Through Acquisitions: Fitch expects Sunac to build its land bank by acquiring companies or projects from other property developers rather than buying land directly. The cooperation with Greentown - although discontinued in 1H15 - to jointly develop projects in Shanghai gave Sunac access to an important market. The company has been seeking acquisition opportunities in new regions and cities, and it announced the acquisition of seven projects in Chengdu in July 2015. Fitch expects other Chinese property developers to also expand their land banks in this manner, given the limited land supply in Tier-1 and key Tier-2 cities.

KEY ASSUMPTIONS

Fitch's key assumptions within our rating case for the issuer include:
- Conservative expansion plan with no aggressive land acquisition in 2H15 and 2016
- Average land costs to increase due to limited land supply and potential fierce competition for land acquisition in its targeted cities
- High single-digit contracted sales growth on an attributable basis
- EBITDA margin to improve slightly from 2H15, but remain at in the high-teens in 2015 and 2016

RATING SENSITIVITIES

Negative: Future developments that may, individually or collectively, lead to negative rating action include:
- Net debt/adjusted inventory sustained above 40% (end-1H15: 30%)
- Attributable contracted sales / Adjusted inventory sustained below 0.7x (end-1H15: 0.9x)
- EBITDA margin excluding impact of revaluation of acquisitions is sustained below 18% (2014: 18%)
- Significant increase in JVs and associates that leads to structural subordination of cash flows
- Material drop in contracted sales on an attributable basis

Positive: No positive rating action is expected unless Sunac substantially increases its contracted sales on attributable basis without significant structural subordination, and establishes core markets in multiple regions without compromising its financial metrics. This is not expected over the medium term.

FULL LIST OF RATING ACTIONS

Long-Term Foreign-Currency IDR upgraded to 'BB' from 'BB-'; Outlook Stable
Senior unsecured rating upgraded to 'BB' from 'BB-'
USD400m 12.5% senior unsecured notes due 2017 upgraded to 'BB' from 'BB-'
USD500m 9.375% senior unsecured notes due 2018 upgraded to 'BB' from 'BB-'
USD400m 8.75% senior unsecured notes due 2019 upgraded to 'BB' from 'BB-'