19.01.2016, 08:21
Fitch Rates Evergrande's USD Notes Final 'BB-'
OREANDA-NEWS. Fitch Ratings has assigned Evergrande Real Estate Group Limited's (Evergrande; BB-/Negative) USD300m 8.0% senior unsecured notes a final 'BB-' rating.
The notes are rated at the same level as Evergrande's senior unsecured rating because they constitute direct and senior unsecured obligations of the company. The assignment of the final rating follows the receipt of documents conforming to information already received. The final rating is in line with the expected rating assigned on 10 January 2016.
KEY RATING DRIVERS
Leverage Stabilised; Remains High: Evergrande's ratings remain constrained by its high leverage, although this has stopped rising rapidly from 0.28x in 2012 and 0.42x in 2013, when the company was expanding aggressively into higher-tier cities. Fitch expects Evergrande's leverage will not fall further over the next 12 months as the leverage reduction from 0.57x in 1H14 to 0.51x in 1H15 was partly supported by the large 54% increase in payables, which is hardly sustainable. Debt increased by 21% and adjusted inventory rose by 31% over the same period.
Improved Geographical Diversification: Evergrande's business profile has been strengthened following its expansion into Tier 1 and Tier 2 cities. Evergrande's contracted sales rose 24% to CNY131bn in 2014 and further increased 53% to CNY201bn in 2015, surpassing its CNY180bn adjusted contracted sales target for 2015. Tier 1 and Tier 2 cities accounted for 63% of its contracted sales in 1H15 compared with 55% in 1H14 and 44% in 2013, indicating that its diversification into higher-tier cities has been well implemented.
High SG&A Expenses: Evergrande's profitability is dragged down by its high sales, general and administrative (SG&A) expenses that amounted to 10% of contracted sales in 2014 and 9.4% in 1H15. This, together with interest payments that amounted to 12% of its contracted sales value in 2014, means that very little of the 30% gross margin of its housing sales is left to support business expansion. This has partly been mitigated by the increased use of lower-cost onshore borrowings to help Evergrande trim its borrowing costs. This change reduced 1H15 interest expenses to 9% of contracted sales.
Active Share Capital Management: Evergrande repurchased shares totalling CNY5.47bn in July 2015, more than the CNY4.6bn it raised in June 2015 from a new share issuance. Although shareholder value has been enhanced because the price of the repurchased shares was 15% less than the price of the shares issued, this cash outflow, together with the CNY6.7bn dividend payable at end-1H15 (which we have deducted from cash in calculating net debt) will put pressure on Evergrande's leverage. The possibility of further share repurchases to enhance shareholder value may be limited because of the falling free-float level.
KEY ASSUMPTIONS
Fitch's key assumptions within our rating case for the issuer include:
- Assume land replenishment rate of 1.1x contracted sales gross floor area
- Contracted sales growth of 5% per annum; land cost and average selling price growth of 3% per annum (to reflect continued increase in exposure to higher-tier cities)
- SG&A expenses to stay at 10% of contracted sales but interest cost to reduce from utilising more onshore borrowings
- Dividend payout ratio of 30% on core earnings
RATING SENSITIVITIES
Positive: As the current rating is on Negative Outlook, Fitch does not anticipate developments with a material likelihood, individually or collectively, of leading to a rating upgrade. However, if Evergrande maintains its 1H15 financial profile, where its net debt/adjusted inventory was at 0.51x and contracted sales/gross debt at 0.73x for the next six months, the Outlook may be revised to Stable
Negative: Future developments that may, individually or collectively, lead to negative rating action include:
- Net debt/adjusted inventory sustained above 0.6x
- Contracted sales/gross debt falls below 0.6x on a sustained basis
- Tightened liquidity position due to weaker access to financing channels.
The notes are rated at the same level as Evergrande's senior unsecured rating because they constitute direct and senior unsecured obligations of the company. The assignment of the final rating follows the receipt of documents conforming to information already received. The final rating is in line with the expected rating assigned on 10 January 2016.
KEY RATING DRIVERS
Leverage Stabilised; Remains High: Evergrande's ratings remain constrained by its high leverage, although this has stopped rising rapidly from 0.28x in 2012 and 0.42x in 2013, when the company was expanding aggressively into higher-tier cities. Fitch expects Evergrande's leverage will not fall further over the next 12 months as the leverage reduction from 0.57x in 1H14 to 0.51x in 1H15 was partly supported by the large 54% increase in payables, which is hardly sustainable. Debt increased by 21% and adjusted inventory rose by 31% over the same period.
Improved Geographical Diversification: Evergrande's business profile has been strengthened following its expansion into Tier 1 and Tier 2 cities. Evergrande's contracted sales rose 24% to CNY131bn in 2014 and further increased 53% to CNY201bn in 2015, surpassing its CNY180bn adjusted contracted sales target for 2015. Tier 1 and Tier 2 cities accounted for 63% of its contracted sales in 1H15 compared with 55% in 1H14 and 44% in 2013, indicating that its diversification into higher-tier cities has been well implemented.
High SG&A Expenses: Evergrande's profitability is dragged down by its high sales, general and administrative (SG&A) expenses that amounted to 10% of contracted sales in 2014 and 9.4% in 1H15. This, together with interest payments that amounted to 12% of its contracted sales value in 2014, means that very little of the 30% gross margin of its housing sales is left to support business expansion. This has partly been mitigated by the increased use of lower-cost onshore borrowings to help Evergrande trim its borrowing costs. This change reduced 1H15 interest expenses to 9% of contracted sales.
Active Share Capital Management: Evergrande repurchased shares totalling CNY5.47bn in July 2015, more than the CNY4.6bn it raised in June 2015 from a new share issuance. Although shareholder value has been enhanced because the price of the repurchased shares was 15% less than the price of the shares issued, this cash outflow, together with the CNY6.7bn dividend payable at end-1H15 (which we have deducted from cash in calculating net debt) will put pressure on Evergrande's leverage. The possibility of further share repurchases to enhance shareholder value may be limited because of the falling free-float level.
KEY ASSUMPTIONS
Fitch's key assumptions within our rating case for the issuer include:
- Assume land replenishment rate of 1.1x contracted sales gross floor area
- Contracted sales growth of 5% per annum; land cost and average selling price growth of 3% per annum (to reflect continued increase in exposure to higher-tier cities)
- SG&A expenses to stay at 10% of contracted sales but interest cost to reduce from utilising more onshore borrowings
- Dividend payout ratio of 30% on core earnings
RATING SENSITIVITIES
Positive: As the current rating is on Negative Outlook, Fitch does not anticipate developments with a material likelihood, individually or collectively, of leading to a rating upgrade. However, if Evergrande maintains its 1H15 financial profile, where its net debt/adjusted inventory was at 0.51x and contracted sales/gross debt at 0.73x for the next six months, the Outlook may be revised to Stable
Negative: Future developments that may, individually or collectively, lead to negative rating action include:
- Net debt/adjusted inventory sustained above 0.6x
- Contracted sales/gross debt falls below 0.6x on a sustained basis
- Tightened liquidity position due to weaker access to financing channels.
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