OREANDA-NEWS. Fitch Ratings has affirmed Hong Kong-based The Wharf (Holdings) Limited's (Wharf) Long-Term Issuer Default Rating (IDR) at 'A-'. The Outlook is Stable. Fitch has also affirmed Wharf's senior unsecured rating at 'A-', and ratings on the senior unsecured notes of Wharf Finance Limited at 'A- '. The full list of rating actions is at the end of this commentary.

The affirmation reflects stable rental income from Wharf's retail property portfolio and its market leadership in this segment in Hong Kong, which provide strong interest coverage. Wharf's China operation continues to constrain its ratings but this pressure is abating as the company will open several malls in China to drive leasing income growth, while cash flow from Wharf's China developments is likely to improve due to better market sentiment and slower land acquisitions. Its financial management remains prudent with good liquidity.

KEY RATING DRIVERS
Solid Retail Portfolio: We still expect Wharf's malls to achieve positive rental reversion in 2015 and flattish rental reversion in 2016 given the prime locations of Harbour City and Times Square. Management is pursuing mall enhancements and capital projects to weather the current retail downturn. Wharf is experienced at upgrading its malls with continued asset enhancement, tenant repositioning and promotional activities. The retail sales of Wharf's tenants may continue to shrink in 2016 due to a weak economic outlook and the strength of Hong Kong dollar against major currencies, which has curbed spending by tourists and residents. International brands have taken measures to harmonise their prices globally, which should help to support retail sales for international brands.

Growing China Rental Contribution: The mall at Chengdu International Finance Square (IFS) became fully operational in 1H15, with retail revenue rising 85% yoy, which is 51% of the mall's full-year retail revenue target of CNY600m. Growth in revenue and operating profit from the China leasing business in 2016 will be mainly driven by Chengdu IFS. Wharf will have two shopping malls starting operations in Chongqing and Changsha in 2017, which will support leasing income growth and make up for slowing HK retail sales growth.

Improving Development Cash Flow: Wharf's contracted sales have reached a level that can fully finance its cash outflows for property development in China. Wharf exceeded its full-year contracted sales target of CNY21.5bn as of November 2015. Its land acquisition costs have declined since 2011. Currently Wharf focuses on prime locations in Tier-one cities and top Tier-two cities. It expanded its contracted sales to CNY21.5bn in 2014 from CNY4.6bn in 2009. As of June 2015, Wharf had 9.6 million square metres (sqm) of land bank in China for property development and property investment. We think its land bank should be sufficient to generate a moderate increase in contracted sales over the next four years, even though it may continue to decelerate land acquisitions in 2016-17.

China Operation Still Constrains Ratings: We think Wharf's China investment strategy increases its risk profile and remains a rating constraint. Wharf is one of the most active Hong Kong firms investing in the China property space. While Wharf achieved about CNY21.5bn of China contracted sales in 2014, other HK developers were making less than CNY10bn. Wharf's investment property portfolio in China is still in the development phase, and it has yet to generate positive free cash flow due to the large capex. There are uncertainties regarding the occupancy rates and EBITDA margins in view of the weak economic outlook in the near term. The investment property portfolio is likely to reach a mature level of operation after 2018, with reduced capex and stable occupancy rates and EBITDA margins.

Prudent Financial Management: We expect Wharf's investment property interest coverage to remain largely stable in the next two years at above 4.0x and above the 2.75x level at which negative rating action may be considered. Wharf has been able to maintain its leverage (net debt/investment portfolio value) at 20%-30% over the past three years, despite its expansion in China. Fitch expects Wharf's leverage to sit comfortably below 25% in 2015, well below the negative rating action trigger of 40%.

KEY ASSUMPTIONS
Fitch's key assumptions within the rating case for Wharf include:
- Rental reversions of 15% in its Hong Kong leasing properties in 2015 and 0% in 2016
- Stable EBITDA margin for HK property leasing in 2015-16 at 80-90%
- Improving China property leasing EBITDA margin from 50% in 2014 to 60% in 2015-16
- China contracted sales growth of 20% in 2015 and 10% in 2016
- Land purchase budget of CNY4-5bn a year in 2015-16
- Capex for investment properties at HKD10bn-12bn a year in 2015-16

RATING SENSITIVITIES
Positive: Fitch does not expect positive rating action in the next 12-18 months, but future developments that may, individually or collectively, lead to positive rating action include:
-Sustained positive free cash flow for its China business (development and investment properties)
-Wharf's China investment property operation reaches maturity with stable occupancy rates and EBITDA margins, and reduced capex
-No deterioration of its financial profile from 2014 level

Negative: Future developments that may, individually or collectively, lead to negative rating action include:
-Investment property EBITDA/gross interest expense sustained below 2.75x (2014: 4.3x), or
-Recurring EBITDA/gross interest expense sustained below 3.5x (2014: 5.0x), or
-Net debt/investment property value approaching 40% (end-2014: 19.6%), or
-Net debt/ recurring EBITDA sustained above 5.5x (2014: 4.7x)

LIQUIDITY
Sufficient Liquidity: At end-June 2015, Wharf had cash balances of HKD16.7bn (end-2014: HKD18.7bn) and committed undrawn credit facilities of HKD17.9bn against short-term borrowings of HKD15.3bn. Wharf's investment property portfolio of HKD306.9bn is mainly unencumbered and it has HKD9.6bn in available-for-sale investments, providing it further financial flexibility.

FULL LIST OF RATING ACTIONS
The Wharf (Holdings) Limited
Long-term Issuer Default Rating affirmed at 'A-'; Stable Outlook
Long-term senior unsecured rating affirmed at 'A-'
Ratings on senior unsecured notes affirmed at 'A-'

Wharf Finance Limited
Ratings on senior unsecured notes affirmed at 'A-'.