OREANDA-NEWS. Fitch Ratings says that China-based Country Garden Holdings Co. Ltd.'s (BB+/Positive) reallocation of resources to improve its operations in Tier 1 and Tier 2 cities in China could cement its position among the few homebuilders in the country that have nationwide presence.

The deployment of resources to the intensely competitive Tier 1 and major Tier 2 cities is a natural extension for Country Garden, which has had a strong market position in Tier 3 and 4 cities for over decade.

The success of this change will enable Country Garden to achieve coverage of Tier 1, 2, 3 and 4 cities across China, which will give it flexibility in its contracted sales mix and improve its ability to weather the cyclicality of China's homebuilding sector. Country Garden's operational leverage as a sizeable nationwide player, its strong market position in Guangzhou, and well-defined region-based management will provide support for its expansion into Tier 1 and 2 cities. Its operations in Tier 3 and 4 cities generate neutral cash flow from operations (CFO), which will provide a financial buffer for Country Garden during the expansion.

In Tier 1 and 2 cities, buyers tend to be first-time buyers or upgraders for high-rise apartments compared with Country Garden's traditional target market of mid- to upper-income homebuyers who are seeking affordable spacious housing on the outskirts of Tier 2 or lower cities. If Country Garden does manage to secure good market niches in Tier 1 and 2 cities though, the reward will be improved profitability, as demand and prices have generally been more resilient in the higher-tier markets.

Fitch expects Country Garden's financial profile to remain stable, but with a temporary increase in leverage. This is in contrast to the rapid deleveraging in 2014. Fitch expects a short-term reversal into negative CFO in the next 12-18 months, as expanding into Tier 1 and major Tier 2 cities is more capital intensive. CFO will likely remain negative in this and next year to support increased development expenditure as pre-sales permits in these cities are often obtained at a later stage of the development cycle than in Country Garden's existing markets.

Country Garden's leverage, as measured by its net debt to adjusted inventory ratio, was 33.8% at end-1H15, which is similar to 36.8% at end-2014. The company launched CNY38bn of new projects in 1H15 and plans to increase this to CNY70bn to CNY80bn in 2H15; which will help generate stronger sales in the second half.

Country Garden intends to maintain the same pace of land acquisition in 2H15 as in 1H15, and keep its net debt level under CNY40bn, despite the need to fund greater development expenditures in the new markets. Net debt at end-June 2015 was CNY37bn.

Fitch revised Country Garden's Outlook to Positive at the start of 2015 due to the reduction in the company's market-specific risks as it diversified geographically, and its rapid deleveraging. An upward rating action may be considered if it maintains net debt-to-net inventory ratio at below 35% on a sustained basis, maintains the contracted sales-to-debt ratio above 2.0x on a sustained basis; and continues to be a large nationwide player. In addition, Fitch will take into account the success of its strategy in the Tier 1 and major Tier 2 cities; and the attainment of neutral or positive cash flows from operations (CFO), which will signal whether it maintained financial discipline while expanding into the top-tier cities.