September 12, 2017 / 9:38 AM / 14 days ago

Fitch Affirms Wuzhou at 'CCC'

(The following statement was released by the rating agency) HONG KONG/SHANGHAI, September 12 (Fitch) Fitch Ratings has affirmed China-based property developer Wuzhou International Holdings Limited's Long-Term Foreign-Currency Issuer Default Rating at 'CCC'. Wuzhou's senior unsecured rating and the rating of its USD300 million senior notes due 2018 have also been affirmed at 'CCC', with the Recovery Rating remaining at 'RR4'. The ratings have been affirmed as Wuzhou's contracted sales have been bottoming and we expect secured borrowings to remain an option for the company to refinance its maturing debt given its large unencumbered asset base. Lower development expenditure and increasing the amount of completed inventory available for sale could also slow the pace of leverage expansion. However, the trend of Wuzhou's weaker contracted sales to end-1H17 and its still-deteriorating leverage does not reflect a sustainable profile and constrains its ratings. KEY RATING DRIVERS Insufficient Cash Flow for Expenses: We estimate Wuzhou's contracted sales, which remain below CNY7.5 billion per annum, will generate insufficient cash flow to cover its high interest and tax expenses. Wuzhou's contracted sales had seen two consecutive years of decline; falling by 32% yoy to CNY4.1 billion in 2016 after declining by 9% to CNY6 billion in 2015. Sales of CNY2.2 billion in 1H17 remained weak, down by 3.4% yoy, but were slightly up from CNY1.9 billion in 2H16. Wuzhou has moved into residential property development and expects to boost its sales in 2H17. A general improvement in lower-tier city housing sales will lower the risk of Wuzhou's business diversification strategy. Climbing Leverage: We expect Wuzhou's leverage to continue climbing in 2017 and 2018 due to weak sales and still-low profit margin. Leverage and sales churn weakened in 2016 and 1H17, performing worse than we had expected. However, profit margin improved. Wuzhou's leverage, measured by net debt/adjusted inventory, jumped to 59.7% in 1H17, from 48.7% in 2016 and 37.3% in 2015. This was partly because Wuzhou acquired three in-progress projects, of which two are residential, which have not generated sales. Wuzhou's EBITDA margin was 8.8% in 1H17, down from 20.9% in 2016, but higher than the -3.5% in 2015. Churn, measured by contracted sales/gross debt, was 0.3x in 1H17, down from 0.4x in 2016 and 1.0x in 2015. Lower Development Expenditure: We believe Wuzhou's construction expenditure is falling as its gross floor area (GFA) under development declined to 1.7 million square metres (sq m) in 1H17, from 1.8 million sq m in 2016 and 2.6 million sq m in 2015. This will slow the pace of completed inventory increase. Wuzhou's completed development properties increased to CNY3.8 billion, from CNY3.5 billion in 2016 and CNY3.1 billion in 2015. These assets are held at cost and do not require additional expenditure, hence cutting completed inventory levels can help the company deleverage. The GFA of its completed inventory is 564,000 sq m, whereas GFA of investment properties totalled 841,000 sq m with a valuation of CNY9.7 billion. Secured Debt Access Instrumental: We estimated that Wuzhou has a large pool of unencumbered assets that may allow it to raise a further CNY5 billion-6 billion in secured borrowing, assuming at maximum loan/value ratio of 60%. The company has capital market debt, including convertible bonds, onshore corporate bonds and offshore senior notes totalling CNY4.8 billion that may require redemption in 2017 and 2018. We do not expect Wuzhou to generate positive free cash flow. It will be tough for Wuzhou to refinance its capital market debt through the issue of new US-dollar senior notes at its rating level, as it has insufficient cash for repayment, even though it has regulatory approval to do so. This means Wuzhou is highly reliant on secured debt financing for the redemption of its capital market debt. Recovery Rating Pressure: Wuzhou's Recovery Rating may come under pressure if its prior-ranking debt increases significantly, due to its high financial leverage. This may happen if Wuzhou borrows a large amount of secured debt to refinance part, but not all, of its offshore debt, or expands its business scale by further relying on onshore debt. DERIVATION SUMMARY Wuzhou's business risk is high due to weak demand for its main trade-centre products stemming from poor sentiment among China's small- to medium-sized enterprises, which comprise most of its customer base. Contracted sales declined in 1H17, 2016 and 2015 and leverage rose to close to 60% in 1H17, from 48.7% in 2016 and 37% in 2015. Wuzhou will not face liquidity risks in the following year, but its financial profile will not be sustainable if sales and collections do not pick up. Compared with China South City Holdings Limited (CSC, B/Stable) and Hydoo International Holdings Limited (B-/Stable), Wuzhou faces greater financial risk because of lower leverage headroom to sustain ongoing capex. Wuzhou's leverage is as high as that of CSC and much higher than that of Hydoo, while its margin is weaker than that of both peers. CSC has a healthy recurring EBITDA/gross interest ratio of 0.5x, putting it in a better position to service its debts and making it more likely to be able to refinance its maturing debts. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: - Land replenishment at 1.2x of GFA sold - Contracted sales of CNY5.8 billion in 2017 and CNY7.4 billion in 2018 - Gross profit margin of 35% (average of 35% between 2013 and 2016, with a low of 24% in 2015) - Annual capex of CNY600 million Recovery rating assumptions - Wuzhou will be liquidated in a bankruptcy because it is an asset trading company - 10% administrative claims The liquidation estimate reflects Fitch's view of the value of inventory and other assets that can be realised and distributed to creditors. - We applied a haircut of 45% to adjusted inventory, slightly higher than the 40% norm used for Wuzhou's homebuilding peers, as trade centre properties face weak demand - We applied a 50% haircut to net property, plant and equipment, including investment properties and prepaid land leases - We assumed Wuzhou's CNY1.5 billion pledged deposits are used to pay debt Based on our calculation of the adjusted liquidation value, after administrative claims, we estimate the recovery rate of the offshore senior unsecured debt to be 45%, which corresponds to a Recovery Rating of 'RR4'. RATING SENSITIVITIES Developments that May, Individually or Collectively, Lead to Positive Rating Action -Sustained improvement in sales and cash collection - Contracted sales/gross debt sustained above 1.0x (12 months to end-June 2016: 0.6x; 2015: 1.0x) - Net debt/adjusted inventory sustained below 40% Developments that May, Individually or Collectively, Lead to Negative Rating Action -Further weakening of liquidity position -Failure to provide plans for the repayment of senior notes and bonds due in 2018 by end-1H18 LIQUIDITY Tight Liquidity: Cash, including pledged cash of CNY1.6 billion, amounted to CNY2.1 billion at end-1H17, covering only half of Wuzhou's short-term debt of CNY4.2 billion. Its USD300 million senior notes are due in September 2018, adding to liquidity pressure. Wuzhou may have to rely on obtaining more secured borrowings with its available unpledged assets, which we estimate at around CNY10 billion at end-1H17. Contact: Primary Analyst Su Aik Lim Senior Director +852 2263 9914 Fitch (Hong Kong) Limited 19/F Man Yee Building 68 Des Voeux Road Central Hong Kong Secondary Analyst Chloe He Associate Director +86 21 5097 3015 Committee Chairperson Ying Wang Senior Director +86 21 5097 3010 Summary of Financial Statement Adjustments - pledged deposits for loans treated as available cash - dues with related parties and prepayments in investing cash flow treated as working capital changes Media Relations: Wai-Lun Wan, Hong Kong, Tel: +852 2263 9935, Email: wailun.wan@fitchratings.com. 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