July 6, 2017 / 3:04 AM / 2 months ago

Fitch Rates Longfor's Proposed USD Senior Notes 'BBB-(EXP)'

(The following statement was released by the rating agency) HONG KONG, July 05 (Fitch) Fitch Ratings has assigned Longfor Properties Co. Ltd.'s (BBB-/Stable) proposed US dollar senior notes a 'BBB-(EXP)' expected rating. The notes are rated at the same level as Longfor'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. China-based Longfor's ratings are supported by its established homebuilding operations, which have been generating healthy cash flow that the company has used to expand its investment property (IP) business. The IP business is likely to generate around CNY2.5 billion-3.0 billion in rental revenue a year in 2017-2018 (2016: CNY1.9 billion). KEY RATING DRIVERS Established, Diversified Homebuilder: Longfor has built a defensive business covering over 20 Tier 1 and 2 cities in China. In 2016, around 31% of its 41.5 million square metres (sq m) of land bank was in western China, where Longfor is a leading player, with a strong brand name in key cities such as Chongqing and Chengdu. Longfor's expansion outside western China has reduced contracted sales from the region to 22% of total sales in 2016 from 41% in 2013. Early Mover in Land Replenishment: Longfor added land in cities such as Beijing, Shanghai, Hangzhou, Nanjing and Suzhou in 2015, before prices ran up in 2016. This head start in land replenishment is likely to support contracted sales growth for the next two years and improve its profitability. These cities, which accounted for 49% of the gross floor area (GFA) Longfor acquired in 2015, made up over 45% of its 2016 contracted sales and over 25% of its GFA sold. In addition, Longfor replenished land in Beijing and Hangzhou in 1H16, but not in Shanghai, Nanjing or Suzhou, as land prices in these cities had risen rapidly. Longfor is focused on acquiring land in cities with lagging growth, such as Jinan and Qingdao, which accounted for around 40% of Longfor's total GFA acquired in 2016. Quality IP Portfolio: Fitch expects Longfor to continue to expand its IP portfolio in 2017-2019. Longfor's urban retail malls in prime locations in Chongqing, Chengdu, Beijing and Hangzhou made up over 80% of its IP portfolio, with the rest made up of community malls that are part of its large residential projects. Fitch estimates the GFA of Longfor's retail malls increased by CAGR of 34.7% to 1.9 million sq m over 2011-2016, and we expect this to increase to 2.5 million-2.7 million sq m by 2017-2018. Its IP revenue increased to CNY1.9 billion in 2016 from only CNY0.4 billion in 2011. Longfor has maintained a high occupancy rate of over 95% for past four years in spite of the expansion, and we forecast the occupancy rate at 93% over 2017-2019. Positive Operating Cash Flow: Fitch expects Longfor to continue to generate positive cash flow from operations (CFO) in 2017 and 2018, extending a trend that started in 2012. The continued positive CFO will support the gradual expansion of its homebuilding and IP businesses. Longfor typically adds two to three new malls a year for its IP business, which was the key contributor of its negative free cash flow. Fitch estimates that Longfor maintained neutral operating cash flow for its homebuilding business segment between 2012 and 2016, even though it more than doubled its contracted sales. Healthy Financials: We expect Longfor's business profile to continue strengthening. Contracted sales in January-May 2017 was CNY76 billion, which was 79% of Fitch's full-year forecast of around CNY96 billion, and compared with CNY88 billion in 2016 and CNY54 billion in 2015. Fitch forecasts Longfor's recurring rental revenue to rise by 20% to around CNY2.3 billion in 2017. Fitch expects Longfor's leverage, as measured by net debt to adjusted inventory (including IP valued at higher of cost or 5% yield), of 31% in 2016 to be little changed for the next 12-18 months, while its total contracted sales to total debt should improve from 1.5x in 2016. Access to Low-Cost Funding: Longfor has access to diversified funding sources and strong access to both domestic and offshore bond markets and banks. Its average cost of borrowing fell to 4.9% in 2016 from 6.7% in 2012 after the company refinanced its offshore debt, which also extended the offshore debt's average maturity. Fitch expects Longfor's interest costs to remain low, with management's focus on maintaining ample liquidity and ready access to various funding channels helping to support its ratings. Constrained by IP Expansion: Longfor's rental revenue of CNY1.9 billion for 2016 was still insufficient to cover its cash investments in this segment of CNY3 billion-5 billion. This was, however, an improvement from 2014, when its rental income was CNY876 million and its cash investments in IP was CNY3.8 billion. The scale of its IP business is still small and accounted for less than 15% of its total EBITDA, leaving the company reliant on its homebuilding operation to support its IP expansion and resulting in persistent negative free cash flow for this segment. DERIVATION SUMMARY Longfor has had stable and healthy positive cash flow from operations (CFO) since 2012. The continued positive CFO will support the gradual expansion of its homebuilding and IP businesses. It is well-positioned among its peers. Its 2016 contracted sales of CNY88 billion is comparable with peers rated 'BBB-' to 'BB+', and its EBITDA margin of 22% in 2015-2016 is comparable with 'BBB' to 'BBB+' rated peers, such as China Resources Land Ltd (BBB+/Stable) and China Vanke Co., Ltd (BBB+/Stable). Longfor's leverage of around 30%-32% is comparable with that of Shimao Property Holding Limited (BBB-/Stable). No Country Ceiling or parent/subsidiary aspects affect Longfor' s rating. Operating environment risks make it difficult for companies in this sector to be rated above 'BBB+'. KEY ASSUMPTIONS Fitch's key assumptions within the rating case for the issuer include: -Investment property income reaches CNY2.5 billion-3.0 billion in 2017-2018 -Contracted sales by GFA to decrease by 0%-6% over 2017-2019 -Average selling price for contracted sales to increase by 2% for 2017-2019 -EBITDA margin of around 22%-23% in 2017-2019 RATING SENSITIVITIES Developments that may individually or collectively, lead to negative rating action include: - Net debt/adjusted inventory (investment property valued at higher of cost or 5% yield) sustained above 40% - Contracted sales/total debt sustained below 1.0x - EBITDA margin sustained below 22% - Sustained weakening of cash flow from operations Developments that may individually or collectively, lead to positive rating action include: -Net debt/adjusted inventory (investment property valued at higher of cost or 5% yield) sustained below 30% -The company's investment property operation stabilises at a larger scale and generates substantially higher recurring income. LIQUIDITY Sufficient Liquidity: Longfor had CNY17 billion of cash, of which CNY0.1 billion was restricted, at end-2016. The company has made opportunistic early repayment for most of its US dollar debt financing in the past. Fitch expects the group to maintain sufficient liquidity to fund development costs, land premium payments and debt obligations during 2016-2018 due to its diversified funding channels and flexible land acquisition strategy. Contact: Primary Analyst Winnie Guo Associate Director +852 2263 9969 Fitch (Hong Kong) Limited 19/F Man Yee Building 68 Des Voeux Road Central, Hong Kong Secondary Analyst Vicki Shen Director +852 2263 9918 Committee Chairperson Su Aik Lim Senior Director +852 2263 9914 Date of Relevant Rating Committee: 5 January 2017 Summary of Financial Statement Adjustments - Value of completed investment properties adjusted to higher of cost or 5% yield, but no higher than book value. 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