OREANDA-NEWS. Fitch Ratings has revised the Outlook of China-based Country Garden Holdings Co. Ltd. (Country Garden) to Stable from Positive, and affirmed its Long-Term Issuer Default Rating (IDR) at 'BB+'. Fitch has also affirmed both Country Garden's senior unsecured rating and its existing notes issued at 'BB+'. A full list of ratings action can be found at the end of this commentary.

The outlook revision reflects our belief that a rating upgrade for Country Garden is unlikely in the next 12 months as the company is adjusting its business mix. Meanwhile, leverage (as measured by net debt-to-adjusted inventory) should remain above 40% in 2016, which would be higher than the past three years' average. Country Garden is repositioning its land bank to target customers in Tier 1 and Tier 2 cities to compete more effectively in the midst of intense competition in the higher-tier cities.

Country Garden's ratings are supported by cash inflow from annual contracted sales of over CNY100bn, strong financial flexibility with low interest cost, and a track record of strong execution. Moving into the higher-tier cities is a positive development in Country Garden's progression towards becoming a nationwide homebuilder. However, this process may take another one to two years to reach fruition if the company continues on its current trajectory.

KEY RATING DRIVERS
Ongoing Land Bank Adjustment: Fitch believes Country Garden will continue to reposition its land bank in the next 12 to 24 months. The repositioning in 2015 was to boost the contribution from products targeted at Tier 1 and 2 cities. In 2015, 52% of the CNY140bn contracted sales came from products targeting these cities. The newly acquired CNY56bn land bank in 2015 is also targeting Tier 1 and 2 cities, of which 67% was located in Tier 1 and 2 cities and 75% were targeting these cities.

Aggressive Expansion Pressures Leverage: Fitch expects net debt to rise to CNY70bn-95bn in 2016 as it continues to adjust its land bank. The total land premium was CNY56bn (CNY43bn on attributable basis) was far beyond its budget of CNY20bn at the start of 2015. This resulted in an increase of leverage (as measured by net debt/adjusted inventory) to 40%, from 36% in 2014. Higher end-2015 gross debt has also lowered its churn - as measured by contracted sales to total debt - to 1.1x from 2.0x in 2014. This is less of an issue, since the higher available cash of CNY36.2bn at end-2015 (from CNY18.7bn at end-2014) will reduce pressure on the higher debt.

Gradual Recovery in Margins: Fitch expects the EBITDA margin to improve to 16% in 2016 from 14% in 2015 with recognition of wider-margin contracted sales. The 2015 EBITDA margin was at its historical low, as the company recognised lower-margin products such as high-rise residential apartments. The thinner margin is also reflected in its lower recognised average selling price (ASP) of CNY6,194 per square metre (sq m) compared with the average recognised ASP of CNY6,611 in 2013 and 2014, as well as average contracted sales ASP of CNY6,615 between 2013 and 2015.

However, Fitch believes the improvement in EBITDA margin will be due to recognition of the wider-margin contracted sales. The EBITDA margin improvement after 2016 will be gradual due to recognition of wider-margin contracted sales and continued destocking of low-margin products. Successful product repositioning will be a positive development - given the better margins, churn and liquidity of the products targeting at Tier 1 and 2 cities.

Financial Control Remains Intact: Fitch believes Country Garden continues to exercise reasonable control of its financial profile even as its land acquisition exceeded its initial budget by a factor of 2.8x. It has demonstrated a financial track record of improving funding flexibility and falling interest costs, where the average borrowing cost decreased to 6.2% in 2015 from 7.6% in 2014.

Corporate Action Potential: Country Garden has stated its share buyback plans, and has made two acquisitions of auxiliary businesses related to homebuilding. Fitch expects the company will continue to make bolt-on acquisitions to strengthen these auxiliary businesses.

KEY ASSUMPTIONS
Fitch's key assumptions within our rating case include:
- Contracted sales by gross floor area to increase by 5% over 2016-2017;
- Average selling price for contracted sales to increase by 8% over 2016-2017;
- EBITDA margin of 2016 improves to 16%-17% and to 20%-23% in 2017;
- Total land cost around CNY35bn-45bn in 2016-2017;
- Net debt including perpetuals to be around CNY70bn-95bn in 2016.

RATING SENSITIVITIES
Positive: Developments that may, individually or collectively, lead to positive rating action include:
- Sustaining trend of neutral or positive cash flow from operating activities;
- Maintaining the ratio of net debt to adjusted inventory below 35% on a sustained basis (2014: 36.8%, 2015: 40.3%);
- Maintaining the ratio of contracted sales to gross debt above 1.5x on a sustained basis (2014:
1.85x, 2015: 1.12x)

Negative: Developments that may individually or collectively, lead to negative rating action include:
- EBITDA margin below 20% on a sustained basis (2014: 18.1%, 2015: 13.9%);
- Maintaining the ratio of net debt to adjusted inventory above 45% on a sustained basis (2014: 36.8%, 2015: 40.3%);
- Maintaining the ratio of contracted sales to gross debt below 1.2x on a sustained basis (2014:
1.85x, 2015: 1.12x)

FULL LIST OF RATING ACTIONS

Country Garden Holdings Co. Ltd.'s
- Affirmed Long-Term IDR at 'BB+'; Outlook revised to Stable from Positive
- Affirmed foreign-currency senior unsecured rating at 'BB+'
- USD900m 7.5% senior unsecured notes due 2020 affirmed at 'BB+'
- USD550m 7.875% senior unsecured notes due 2019 affirmed at 'BB+'.