OREANDA-NEWS. January 26, 2016. Fitch Ratings has downgraded the Long-Term Issuer Default Rating (IDR) of Hydoo International Holding Limited (Hydoo) to 'B-' from 'B'. The Outlook is Stable. The Chinese property developer's senior unsecured rating and the rating on its outstanding USD100m senior notes have also been downgraded to 'B-' from 'B' with Recovery Rating of 'RR4'.

The downgrade reflects Fitch's view that sales of trade centre and logistic property in China will be depressed in the next 18-24 months due to slower macro-economic growth, declining local government spending on infrastructure, and lower investor appetite. Fitch believes that Hydoo's performance will track the industry's over this period given its small scale and its focus on lower-tier cities. As a result, Hydoo will likely achieve contracted sales below CNY6.5bn in 2016 and 2017, which will also mean that its leverage, as measured by net debt/adjusted inventory, will be sustained above 30%. These were guidelines for a negative rating action when Hydoo was rated at 'B'.

The Stable Outlook reflects Hydoo's flexibility in its land purchases, which will help it to maintain a leverage of no higher than 30%, and its adequate liquidity position.

KEY RATING DRIVERS

Weak Demand for Trade Centres: Contracted sales for trade centre and logistic developers have been weak in 2015. This has been driven by China's growth slowdown, resulting in SMEs adopting a wait-and-see approach to their investments. In addition, relocation demand and the progress in infrastructure development around Hydoo's projects by local government have decelerated. We expect the weak sales for Chinese trade centre and logistic developers to persist in the next 18-24 months amid the challenging market.

Lower-Tier Cities More Risky: Hydoo's trade centres are mainly in Tier 3 and Tier 4 cities spread across 10-12 cities to tap relocation and urbanisation demand. Fitch believes sales are more volatile in these cities than in more developed cities, and demand may reach saturation faster due to the smaller populations and GDP in these economies. Sales for the subsequent phases of Hydoo's large-scale integrated trade centre projects (those that are 400,000 square metres or larger) would hinge on continued urbanisation, which may slow because of greater market uncertainty.

Increasing Leverage: Fitch believes Hydoo's leverage will rise to above 30% by 2016 from quite a low level of 18% at end-1H15 because of slower sales and increased construction to expand its business scale. Hydoo's leverage will continue to increase until its sales can be sustained above CNY6.5bn because of continued capex, even if it reduces land acquisitions. Hydoo's large land bank of 10 million sqm available for future development gives it flexibility in cutting land purchases.

Convertible Bond Redemption Pressures Liquidity: Pingan Real Estate Capital Limited, the sole noteholder of Hydoo's USD120m (about CNY790m) convertible bond, on 14 January 2016 redeemed USD40m of the bond, and revised the terms of the bond to allow early redemption from 11 January 2016. Hydoo's liquidity is sufficient with unrestricted cash balances of CNY1.4bn to cover short-term debt of CNY801m at end-1H15. Hydoo also has unutilised uncommitted bank facilities of CNY26.55bn at end-1H15. However, the risk that Pingan could redeem the convertible bond early will continue to pressure Hydoo's short-term liquidity.

Low Recurring Non-Development Income: Hydoo's business profile is constrained by its focus on trade centre development and low recurring non-development income. As of 1H15, rental income contributed to 1% of the revenue. The lack of diversification results in Hydoo's weaker cash flow quality and increases its operation risk amid industry downturns. If market demand continues to be weak, Hydoo may need to trim average selling prices (ASPs) and reduce margin to speed up sales, which may materially reduce its operational cash flow generation.

KEY ASSUMPTIONS

Fitch's key assumptions within the rating case for Hydoo include:
- Contracted sales ASP growth of 5% in 2016
- Growth in contracted sales in terms of gross floor area (GFA) of 10% in 2016
- EBITDA margin of around 18%-20% over 2015-2017
- Total debt of around CNY5.3bn including convertible bonds in 2016

RATING SENSITIVITIES

Future developments that may, individually or collectively, lead to negative rating action include:
- deterioration in refinancing prospects that has significant adverse impact on its liquidity profile

Future developments that may, individually or collectively, lead to positive rating action include:
- EBITDA margin sustained above 25%
- Net debt/ adjusted inventory sustained below 40%
- Contracted sales / total debt sustained above 1.5x
- Annual contracted sales sustained above CNY6.5bn in next two years

FULL LIST OF RATING ACTIONS

Hydoo International Holding Limited
Long-Term Foreign-Currency Issuer Default Rating downgraded to 'B-' from 'B'; Outlook Stable
Foreign-currency senior unsecured rating downgraded to 'B-' from 'B'; Recovery Rating of 'RR4'
Rating on USD100m 13.75% senior unsecured bond due 2018 downgraded to 'B-' from 'B'; Recovery Rating of 'RR4'