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Fitch Rates China South City's Proposed USD Notes 'B(EXP)'
March 2, 2017 / 4:07 AM / 7 months ago

Fitch Rates China South City's Proposed USD Notes 'B(EXP)'

(The following statement was released by the rating agency) HONG KONG, March 01 (Fitch) Fitch Ratings has assigned China South City Holdings Limited's (CSC; B/Stable) proposed US dollar senior notes a 'B(EXP)' expected rating and a Recovery Rating of 'RR4'. The notes are rated at the same level as CSC's senior unsecured rating because they constitute its direct and senior unsecured obligations. The final rating is subject to the receipt of final documentation conforming to information already received. CSC's ratings are supported by well-located projects, growing non-development income, close collaboration with local governments, a long record in integrated trade centre development and sufficient liquidity. The ratings are constrained by CSC's rising leverage and weak industry outlook. KEY RATING DRIVERS Rising Non-Development Income: Income from CSC's non-development business increased by 22% yoy in the first half of the financial year ending March 2017 (FY17) to HKD736m, driven by growth across the rental, property management, logistics and warehousing segments as well as the outlets and e-commerce businesses. Fitch believes CSC's diversification will enhance internal cash flow and smooth sales volatility, and expects non-development income/interest coverage to exceed 1.0x in the next year or two (last 12 months (LTM) to 1H17: 0.8x). Higher Leverage: CSC's leverage, measured by net debt/adjusted inventory, rose to 48% at end-September 2016, from 38% at end-March 2015, due to increasing construction activities for saleable residential products and investment properties. The company has 15.4 million square metres (sq m) of properties under development and unsold completed properties, including investment properties, as at end-September 2016, compared with 13.3 million sq m a year earlier. Fitch expects leverage to be around 50% in FY17 then remain between 50%-60% for the next two to three years if CSC continues with capex of HKD8.5bn-9bn a year in our estimate, taking into consideration the construction expenditure to build up saleable residential resources and the company's strong emphasis on the recurring business segment. Fitch believes the developer's rising leverage is mitigated by its growing recurring income. However, CSC's ratings will come under pressure if the non-development segment fails to grow despite continued investment. Residential Sales Support Performance: Contracted sales rose 32% yoy to HKD6.7bn in the first nine months of FY17, buoyed by strong sales in three Tier 2 cities - Nanchang, Hefei and Nanning. Residential sales accounted for more than 70% of total contracted value. Average selling prices decreased by 12% over the same period in FY16, to HKD7,800 per sq m, due to product-mix changes. Fitch expects contracted sales to reach HKD7.5bn-8.0bn in FY17 as residential markets in the above-mentioned three cities remain strong and the company had 4.5 million sq m of saleable resources as at end-September 2016. Weak Demand for Trade Centres: Demand in the trade and logistics centre sector has been weak since late 2014 as small and medium-sized enterprises withhold investment amid weaker economic growth, while relocation demand has slowed, local governments delay completing transportation networks and investor appetite has declined. Fitch does not see any signs of recovery in demand for trade centre space in the next 12-18 months. Sustained EBITDA Margin: CSC's EBITDA margin remained satisfactory at 33.6% in the last 12 months to September 2016, given low weighted-average land costs of CNY301 (HKD350) per sq m in 1HFY17, increasing government grants due to the market downturn, which totalled HKD741m (FY16: HKD1bn), and larger recurring EBITDA from the non-development segment. CSC also has the flexibility of cutting selling, general and administrative expenses to maintain a healthy margin. Fitch expects CSC's EBITDA margin to remain above 30% in the next year or two, providing a buffer to absorb average selling price volatility. DERIVATION SUMMARY CSC's projects are located in Tier 1 and 2 cities in China, which are better located than those of the other two Fitch-rated trade centre developers - Hydoo International Holding Limited (B-/Stable) and Wuzhou International Holdings Limited (CCC), whose projects are mainly in Tier 3 and 4 cities. This translates into larger scale and better EBITDA margins for CSC compared with its peers in the same industry. CSC's leverage is higher than that of Hydoo and Wuzhou, given part of its cash is tied up in the construction of investment properties. Fitch expects its diversification into the non-development segment to generate stable operational cash flow for the company. KEY ASSUMPTIONS Fitch's key assumptions within the rating case for CSC include: - Contracted sales to remain weak, at HKD7.5bn-8.0bn each year in FY17-FY19. - Non-development income to increase to HKD1.8bn in FY17 and HKD2bn in FY18. - Capital expenditure at HKD8.5bn-9.0bn per year in FY17-FY19. - Land replenishment ratio (land acquired/gross floor area presold) at 2x in FY17-FY19 (FY16: 2.2x). RATING SENSITIVITIES Developments that may, individually or collectively, lead to negative rating action include: - EBITDA margin sustained below 20% (FY16: 32.5%; LTM1H17: 33.6%); - net debt/adjusted inventory sustained above 50% (FY16: 48.3%; 1HFY17: 48%) if non-development income/interest is below 1.0x (FY16: 0.8x; LTM1HFY17: 0.8x); and - net debt/adjusted inventory sustained above 60% if non-development income/interest is above 1.0x. No positive rating action is expected in the next 12-18 months given persistent weak demand for trade and logistic centres. LIQUIDITY CSC had cash and cash equivalents, including restricted cash, of around HKD8.3bn and unutilised banking facilities of HKD5.4bn as at end-September 2016, covering short-term debt of HKD7.3bn. CSC's successful issuance in the onshore bond market has also alleviated refinancing pressure and lowered its average borrowing cost to 6.2% at end-September 2016, from 6.8% at FYE15. Contact: Primary Analyst Rebecca Tang Associate Director +852 2263 9969 Fitch (Hong Kong) Limited 19/F Man Yee Building 60-68 Des Voeux Road Central, Hong Kong Secondary Analyst Laura Long Analyst +86 21 5097 3019 Tertiary Analyst Chloe He Associate Director +86 21 5097 3015 Committee Chairperson Su Aik Lim Senior Director +852 2263 9914 Date of Relevant Ratings Committee: 12 January 2017 Media Relations: Wai-Lun Wan, Hong Kong, Tel: +852 2263 9935, Email: wailun.wan@fitchratings.com. Additional information is available on www.fitchratings.com Applicable Criteria Criteria for Rating Non-Financial Corporates (pub. 27 Sep 2016) here Additional Disclosures Solicitation Status here Endorsement Policy here ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: here. 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