OREANDA-NEWS. December 23, 2015. Fitch Ratings has upgraded China Overseas Land & Investment Limited's (COLI) Long-Term Issuer Default Rating (IDR) to 'A-' from 'BBB+'. The Outlook is Stable. Fitch has also upgraded COLI's foreign-currency senior unsecured rating and the notes guaranteed by COLI to 'A-' from 'BBB+'. A full list of rating action can be found at the end of this commentary.

The upgrade reflects a one-notch uplift from its standalone rating of 'BBB+', in line with Fitch's bottom-up approach detailed in its Parent and Subsidiary Linkage Criteria. COLI is 61%-owned by China State Construction Engineering Corporation Ltd (CSCECL, A/Stable), the largest construction company in China, which is ultimately owned by the sovereign (A+/Stable). CSCECL's rating incorporates a three-notch uplift from its standalone rating due to its strong strategic and operational linkage with the sovereign. CSCECL plays a leading role in multiple areas of the Chinese construction sector.

Fitch believes that part of the strategic role that CSCECL plays in the field of housing construction is due to its ownership of COLI. COLI is now CSCECL's major homebuilding platform after CSCECL injected 10.9 million square metres (sqm) of gross floor area (GFA) of land into COLI, which was completed on 18 May 2015.

Fitch believes that the Ministry of Housing and Urban-Rural Development (MOHURD) views CSCECL and COLI as an integrated entity with construction and homebuilding expertise, which makes it an ideal central state-owned enterprise (SOE) to execute the ministry's policies and objectives, particularly in spearheading the upgrading or redevelopment of the large amount of China's old housing stocks built before the 1990s.

COLI's standalone rating of 'BBB+' reflects the company's satisfactory contracted sales of HKD165.6bn for January to November 2015 (2014: HKD140.81bn) and its ability to maintain a strong EBITDA margin of 31% despite the challenging market conditions. COLI continues to maintain its leadership position, strong execution track record and consistent financial policy. The Stable Outlook reflects Fitch's expectation that COLI's operations will remain stable and integral to CSCECL.

KEY RATINGS DRIVERS

Homebuilding Operation of Strategic Importance: The operations of COLI and CSCECL are closely aligned to MOHURD's duties in regulating and developing both construction and housing activities in urban and rural areas in China. As China's housing needs shift from building enough homes to that of providing comfortable housing, the complex and long-term task to upgrade China's old housing stocks, especially those built before 1990, will have to be spearheaded by SOEs. CSCECL - with input from COLI - works closely with MOHURD in this area because it is the only SOE owned by the central government that has the expertise and market leading positions in both construction and housing.

Sales Continue to Grow: Fitch expects COLI to deliver contracted sales growth in 2016 after achieving 23.6% yoy growth for the first 11 months of 2015. We believe COLI remains on track to meet its 2015 contracted sales target of HKD180bn. This is despite the company having reduced its land acquisitions to CNY12.6bn in the year to November 2015 from CNY38.3bn for the whole of 2014. However, the smaller land purchases will improve its operating cash flow. COLI's continued sales growth in 2016 will be supported by a combination of its existing land bank and the sites in Tier-1 and -2 cities it acquired from its parent, which increased its land bank by 29% to around 48.3 million sqm.

Strong Cash Generation to Wane: Fitch expects COLI to generate very strong operating cash flow in 2015, which will significantly reduce its leverage, as measured by net debt/adjusted inventory, to a single-digit level from 19.5% in 2014. Increasing development expenditure in 2016 to support COLI's sales growth will, however, moderate COLI's leverage improvement. We believe COLI will continue to replenish the land it sold, but is under no pressure to build up its land bank. The current land bank is sufficient to support sales for the next three to four years. We expect COLI's leverage to revert to its previous level of around 15%-20% in three to four years.

Diversified Funding Enhances Liquidity: COLI also has one of the lowest borrowing costs among Chinese homebuilders. Its weighted average borrowing cost was 4.3% at end-June-2015, compared with 3.7% at end-2014. Its low funding costs are the result of access to the offshore bond and loan markets, and its SOE status, which aids access to domestic funding. COLI continues to maintain a strong liquidity position and had HKD9.6bn in undrawn committed bank facilities and cash balance of HKD78bn at end-June 2015.

Strong Business Profile Maintained: COLI has continued to generate high EBITDA margins of 30% in 2013 and 31% in 2014, even as margins in the industry have fallen to the 25% range from 30% in previous years. COLI's strong branding and its presence in all the high-growth economic zones around the Pearl River Delta, Yangtze River Delta, Bohai Rim, and the northern and western regions puts it in a strong position to benefit from the shift towards upgrading demand. This is demonstrated by its firm average selling price (ASP), which has remained between CNY12,000 and CNY13,000, compared with the ASP of most nationwide homebuilders that were between CNY10,000 and CNY13,000.

KEY ASSUMPTIONS

Fitch's key assumptions within our rating case for the issuer include:
- Contracted sales by GFA to increase by 0%-5% over 2015-2017;
- Average selling price for contracted sales to be flat for 2015-2017;
- EBITDA margin of around 25%-27% 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
-Weakening linkages between COLI, the parent company and the central government; or
-Decline in EBITDA margin to less than 25% (2014: 31%, 1H15: 31%); or
-Deterioration in net debt/adjusted inventory to above 30% over a sustained period (2014: 19%, 1H15:12.5%); or
- Contracted sales/ net inventory remaining below 0.8x over a sustained period. (2014: 0.7x, 1H15: 0.7x); or
- Significant change from its current focus on first-time homebuyers and upgraders.

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.

FULL LIST OF RATING ACTIONS

China Overseas Land & Investment Limited
- Long-Term IDR upgraded to 'A-' from 'BBB+'; Outlook Stable
- Senior unsecured rating upgraded to 'A-' from 'BBB+'

China Overseas Finance (Cayman) III Limited
- USD500m 3.375% senior unsecured notes due 2018 upgraded to 'A-' from 'BBB+'
- USD500m 5.375% senior unsecured notes due 2023 upgraded to 'A-' from 'BBB+'
- USD500m 6.375% senior unsecured notes due 2043 upgraded to 'A-' from 'BBB+'

China Overseas Finance (Cayman) VI Limited
- USD800m 4.250% senior unsecured notes due 2019 upgraded to 'A-' from 'BBB+'
- USD700m 5.950% senior unsecured notes due 2024 upgraded to 'A-' from 'BBB+'
- USD500m 6.450% senior unsecured notes due 2034 upgraded to 'A-' from 'BBB+'

China Overseas Land International (Cayman) Limited
- EUR600m 1.75% senior unsecured notes due 2019 upgraded to 'A-' from 'BBB+'