OREANDA-NEWS. Fitch Ratings has assigned Longfor Properties Co. Ltd. (Longfor) a Long-Term Issuer Default Rating (IDR) of 'BBB-'. The Outlook is Stable. Fitch has also assigned Longfor a foreign-currency senior unsecured rating of 'BBB-' and its outstanding senior unsecured notes 'BBB-' ratings. A full list of rating actions can be found at the end of this commentary.

China-based Longfor's ratings are supported by its established homebuilding operations, which have been generating healthy cash flow that the company used to support the expansion of its investment property (IP) business. The IP business likely generated around CNY1.5bn in rental revenue in 2015 (2014:CNY876m).

Longfor has maintained healthy leverage despite the high capex needed for the IP business because its rental income increased by three-fold and contracted sales for its homebuilding business expanded by 33% between 2015 and 2012. Fitch expects the expansion of the IP business to drive leverage to close to 40% in 2016 from the 30% we estimate for 2015. Longfor's ratings are constrained by the small scale of its IP business.

KEY RATING DRIVERS

Established, Diversified Homebuilder: Longfor has built a defensive homebuilding business with good geographical diversification covering over 20 Tier 1 and 2 cities in China. In 1H15, around 32.5% of its 31 million sqm land bank was in western China, where Longfor is a leading player with a strong brand name in key cities such as Chongqing and Chengdu. Longfor's expansion outside western China has reduced contracted sales from the region to 34.3% of the total in 2014 compared with 41% in 2013.

Healthy Financials: We expect Longfor's business profile to continue strengthening, with contracted sales of CNY54.5bn in 2015 compared with CNY49bn in 2014, and its recurring rental revenue growing 71% to CNY1.5bn in 2015. Its leverage - as measured by net debt to adjusted inventory (including IP valued at higher of cost or 5% yield) - is also likely to remain healthy, falling to 29.9% in 2015 from 32.4% in 2014, while its total contracted sales to total debt should remain at around 1x in 2015.

Positive Homebuilding Cash Flow: Fitch expects Longfor to continue to generate positive cash flow from operations (CFO) in 2015, following total CFO of CNY36.9bn between 2012 and 2014. The continued generation of positive CFO will support its gradual expansion in its homebuilding and IP businesses. Longfor typically adds two to three new malls for its IP business.

Quality IP Portfolio: Urban retail malls in prime locations in Chongqing, Chengdu, Beijing and Hangzhou made up 84% of Longfor's IP portfolio, with the remaining comprising community malls that are part of its large residential projects. The gross floor area (GFA) of Longfor's retail malls increased by CAGR of 44% to 1.2 million sqm by 1H15 from 2011 and we expect this to increase by another 108% to 2.5 million sqm by 2017. Longfor has maintained a high occupancy rate of over 95% for past four years in spite of the expansion, and we assume Longfor will maintain a 93% occupancy rate for our 2015-2018 forecasts.

Rental Performance to Stay Healthy: Fitch expects Longfor's rental yield, as measured by rental revenue-to-completed IP at valuation, to trend above 5% from 2015 because more malls will contribute revenue from a full year of operations and the drag caused by mall launches will reduce as the scale of the portfolio expands. The fast pace of Longfor's IP expansion has resulted in its rental yield for 2014 falling to 3.4% from a high of 4.85% in 2011, putting it behind other Chinese investment property companies that generate yields of around 5%. Longfor's rental rates perform better when the newly opened malls are stripped out - rental revenue posted a CAGR of 14.8% between 2011 and 1H15 for malls that have been in operation since 2011. This growth is largely driven by rental rates increase.

Access to Low Cost Funding: Longfor has access to diversified funding sources and has strong access to both domestic and offshore bonds and banks markets. Its interest costs fell to around 6% annualised in 1H15 from 6.7% in 2012 after the company refinanced its offshore debt, which also extended the offshore debt's average maturity. Fitch expects Longfor's interest costs to decline as lower-cost domestic bond financing is now available for homebuilders. Management's focus on maintaining both ample liquidity and ready access to various funding channels further supports its ratings.

IP Expansion, Small Scale Constrains Ratings: Longfor's rental revenue for 2015, which we estimate to be close to CNY1.5bn, is still insufficient to cover its cash investments in investment properties of over CNY3bn. This is however an improvement from 2014 where its rental income was CNY876m and its cash investments in investment properties was CNY3.8bn. Its IP business contributed to less than 15% of its total EBITDA, leaving the company reliant on its homebuilding operation to support its IP expansion. Furthermore, the company has been generating negative free cash flow indicating its operating cash flow is not yet able to keep pace with the rapid IP expansion.

KEY ASSUMPTIONS

Fitch's key assumptions within the rating case for the issuer include:
- Investment property income reaches CNY2bn in 2017
- Contracted sales by GFA to decrease by 0%-5% over 2016-2018;
- Average selling price for contracted sales increase by 15% for 2016-2018;
- EBITDA margin of around 23%-25% in 2016-2018

RATING SENSITIVITIES

Negative: Future developments that may individually or collectively, lead to negative rating action include:
- Net debt/adjusted inventory (investment property valued at higher of cost or 5% yield) sustained above 40%
- Contracted sales/total debt sustained below 1.0x
- EBITDA margin sustained below 22%
- Sustained weakening of cash flow from operations

Positive: Positive rating action is unlikely until the company's investment property operation stabilises at a larger scale and generates substantially higher recurring income.

FULL LIST OF RATING ACTIONS

Longfor Properties Co. Ltd.
- Long-Term IDR assigned at 'BBB-'; Outlook Stable
- Senior unsecured rating assigned at 'BBB-'
- Rating on CNY2bn 6.750% senior unsecured notes due 2018 assigned at 'BBB-'
- Rating on USD400m 6.875% senior unsecured notes due 2019 assigned at 'BBB-'
- Rating on USD500m 6.750% senior unsecured notes due 2023 assigned at 'BBB-'