OREANDA-NEWS. September 03, 2015. Fitch Ratings has assigned Yuzhou Properties Company Limited (Yuzhou) a Long-Term Foreign-Currency Issuer Default Rating (IDR) of 'BB-' with Stable Outlook and a senior unsecured rating of 'BB-'. The full list of rating actions is at the end of this commentary.

Yuzhou's rating is supported by its strong position in core markets, favourable margin compared with that of its peers, healthy liquidity and moderate leverage. The key uncertainty is the progress of its expansion into new cities, namely Nanjing and Shanghai, which could not only increase its contracted sales and enhance its presence in the Yangtze Delta region, but also lower its margin level and increase leverage.

KEY RATING DRIVERS

Strong Core Markets Advantage: Yuzhou's leadership in its core markets has supported steady growth in contracted sales in the past, and has provided a strong base for expansion into other cities, especially those within neighbouring provinces. Yuzhou has leading market positions in Fujian Province's top three cities, and has successfully expanded into Hefei, the capital city of Anhui Province. It was the No.1 homebuilder by sales in Xiamen for 10 consecutive years, where its brand helps it to secure premium pricing and a high gross margin of around 30%. In Hefei, Yuzhou has six projects, five of which are under development, and it is among the four biggest homebuilders by sales.

Scale Expansion Potential: The company seeks to replicate its success in Xiamen and Hefei in new markets like Shanghai, Fuzhou and Nanjing. In the next three to five years, it aims to achieve annual contracted sales of CNY5bn in each of these five cities, solidifying its regional presence. The establishment of robust operations in Nanjing and Shanghai will help Yuzhou to set up core markets in two regions - West Strait Economic Zone and Yangtze River Delta. This will improve the company's economies of scale, and mitigate the negative effects of market-specific factors, such as demand-supply imbalances or changes in government policies that affect a single city or region.

Favourable Margin Compared with Peers: Yuzhou's EBITDA margin is well above the average 20% of 'BB-' rated homebuilders in China. Its margin was 29% in 1H15 and 31% in 2014 and has historically been between 25% and 35%. Yuzhou is committed to a prudent land acquisition policy, which has limited the ratio of land costs to average selling prices to around 20%. Meanwhile, the company targets both first-time home buyers and upgraders, which helps it to maintain a moderate sell-through rate, and hold reasonable inventory while maximising margin through high-end, high-quality projects. If Yuzhou expands aggressively into new cities, we expect the margin to narrow from 2017. In that case, Fitch would assess the rating impact the lower margin will have against the increase in contracted sales.

Healthy Liquidity: Yuzhou's current liquidity position is healthy and strong, which supports its planned expansion. At end-June 2015, Yuzhou had total cash of CNY7.7bn and an undrawn credit facility of CNY3.1bn, which exceeded its short-term debt of CNY3.4bn. The company has also established diversified funding channels, including onshore and offshore capital markets, and raised HKD792m from new share issuance in May 2015 to ensure the sustainability of its liquidity.

Moderate Leverage: Yuzhou has maintained a healthy leverage, as measured by net debt to adjusted inventory, of 29% at end-2014, which is comparable to the level of about 35% for other Chinese homebuilders rated 'BB-'. Yuzhou's leverage at end-June 2015 rose to 33% as a result of higher land acquisitions in 1H15 relative to its contracted sales. This will reverse in the second half as the company's sales increase, given it will have 1.6 million sqm of saleable GFA versus 0.6m GFA sold in 1H15. We expect its leverage will stay around 35% in the next two years as a result of its planned expansion.

KEY ASSUMPTIONS

Fitch's key assumptions within our rating case for the issuer include:
- Average selling price will increase from 2016 onwards, as Yuzhou increases exposure in Tier 1 and Ttier 2 cities like Shanghai and Nanjing, which have higher average selling prices than its core markets in Xiamen, Hefei, and Fuzhou
- GFA sold will increase due to its expansion plan into new cities, and its current large land reserve
- Land costs to increase faster than average selling prices as the company has fewer channels to acquire land in cities it is entering compared with its established markets in Xiamen and Hefei
- As a result of the rapid increase in land costs, EBITDA margin will gradually drop from 30% to 20%-25% in 2017

RATING SENSITIVITIES

Negative: Future developments that may, individually or collectively, lead to negative rating action include:
- EBITDA margin sustained below 25%
- Net debt/adjusted inventory sustained above 35%
- Contracted sales / net inventory sustained below 0.8x (0.8x for last twelve months ending June 2015)
- New markets (Shanghai, Nanjing, and Fuzhou) fail to make up at least 20% of contracted sales by 2017

Positive: No positive rating action is expected unless Yuzhou is able to substantially increase its scale, and establish a core market in the Yangtze River Delta without compromising its financial metrics. This is not expected over the next 12-18 months.

FULL LIST OF RATING ACTIONS

- Long-Term Foreign-Currency IDR rating assigned at 'BB-', Outlook Stable
- Senior unsecured rating assigned at 'BB-'
- USD250m 11.75% senior unsecured notes due 2017 assigned rating at 'BB-'
- USD300m 8.75% senior unsecured notes due 2018 assigned rating at 'BB-'
- USD300m 8.625% senior unsecured notes due 2019 assigned rating at 'BB-'
- USD250m 9.0% senior unsecured notes due 2019 assigned rating at 'BB-'