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Fitch Downgrades Sunac to 'BB-'; Places On Watch Negative
July 12, 2017 / 9:15 AM / 5 months ago

Fitch Downgrades Sunac to 'BB-'; Places On Watch Negative

(The following statement was released by the rating agency) HONG KONG, July 12 (Fitch) Fitch Ratings has downgraded Sunac China Holdings Limited's (Sunac) Long-Term Foreign-Currency Issuer Default Rating (IDR), its senior unsecured rating and the rating on its outstanding USD400 million 8.75% senior notes due 2019 to 'BB-' from 'BB'. Fitch has also put all the ratings on Watch Negative. Sunac's ratings have been downgraded to reflect the company's acquisitive business approach, which will make its financial profile more volatile. Current industry dynamics, where land bank expansion through project acquisition is prevalent, will likely drive Sunac to continue making acquisitions. As a result, leverage, as measured by net debt/adjusted inventory, is likely to be changeable, after it jumped to 60% by end-2016, from 26% and 19% at end-2015 and end-2014. Sunac's ratings are on Rating Watch Negative (RWN) because its plan to acquire Dalian Wanda Commercial Property Co. Ltd.'s (Wanda, BBB/Negative) assets will put pressure on Sunac's leverage over the next 12 months. The acquisition price, including debt to be acquired, according to our estimate using Wanda's publicly available 2016 financial reports, is almost as large as Sunac's net adjusted debt of CNY89 billion at end-2016. The acquisition, however, will enhance the business profile and profitability of Sunac's property development business, KEY RATING DRIVERS Acquisitive Business Approach: Sunac's financial profile has become less predictable as it continues to seek significant acquisitions to boost business scale and build its land bank. Sunac on 10 July 2017 agreed to acquire CNY63.17 billion of property assets from Wanda, after it purchased CNY14 billion of property assets from Legend Holdings in 2016. Prior to the planned Wanda acquisition Fitch expected Sunac in 2017 to bring down its high leverage. Moderation of Sunac's financial profile following acquisitions is now more uncertain in an environment where land bank expansion through project acquisition is widely practiced across the industry. Sunac's volatile financial profile, although in service of significant business scale growth, is no longer commensurate with a 'BB' rating. Mixed Impact from Wanda Deal: Fitch believes Sunac's homebuilding business will be strengthened by the Wanda deal and the pressure on Sunac's leverage will eventually ease over time. Under the agreement, Wanda will sell to Sunac a 91% stake in 13 Wanda City projects for CNY29.6 billion (including assumption of project debt) and 76 hotels for CNY33.6 billion. Both companies have agreed to finalise the terms of the transaction by 31 July 2017; and to complete the transactions, and asset and share transfers as early as practicable. This large acquisition by Sunac will have limited impact on its liquidity position, but will lead to a significant increase in its net debt position. This will, however, be mitigated by Sunac's slower land acquisition in 2017, the higher profit margin of the acquired Wanda City projects than Sunac's current portfolio, and possible faster pace of sales of the Wanda City projects. The transaction will cause a spike in Sunac's leverage in 2017 and possibly subsequent years, depending on the final terms of the transaction. No Benefit from Hotels Acquired: Sunac's acquisition of Wanda's hotel assets, however, will not bring immediate enhancement to Sunac's business profile nor financial profile, as the hotel business in China generally has a low return on investment because they are typically developed as part of larger mixed-use projects to get the approval of local governments. In addition, the EBITDA margin of these hotels is likely to be lower than that of Sunac's existing business. Diversification and Business Synergies: Sunac's property development business may benefit from this transaction with Wanda. The addition of the Wanda City land bank will increase by more than 80% Sunac's land bank of 50 million square metres (sqm) in attributable gross floor area (GFA) at end-2016, by our estimate. Sunac's geographical diversification will also improve as the majority of the Wanda City projects are in provincial capitals in new Tier 2 cities. Post-Acquisition Financial Profile: The resolution of the RWN will depend on whether this transaction is completed; and if it does, Sunac's financial profile in the 12 to 24 months following the completion of the transaction. The possible outcomes following the resolution of the RWN are discussed in the Rating Sensitivities. DERIVATION SUMMARY Sunac's homebuilding business scale, geographical diversification, project execution track record, and churn rates are comparable to Country Garden Holdings Co. Ltd. (BB+/Stable); and comparable or superior to Beijing Capital Development Holding (Group) Co., Ltd. (BBB-/Stable; standalone BB/Stable), and Guangzhou R&F Properties Co. Ltd's (BB/Stable). However, Sunac has a more volatile financial profile than these companies. Its financial profile is more comparable with those of lower rated issuers like Greenland Holding Group Company Limited (BB/Negative, standalone BB-/Negative) and China Evergrande Group (B+/Stable); even though its 2016 leverage is lower than those of Greenland and Evergrande. KEY ASSUMPTIONS Fitch's key assumptions within our rating case for the issuer include: - Sunac maintaining a land replenishment rate (GFA acquired/GFA sold) of around 1.5x-2.0x for long-term development - Margin pressure to increase from 2018 onwards, with EBITDA margin dropping to between 15% and 20% RATING SENSITIVITIES Future Developments That May, Individually or Collectively, Lead to Negative Rating Action; - If the transaction takes place and after reviewing transaction information, the ratings may be downgraded if net debt/adjusted inventory exceeds 50% on a sustained basis and attributable contracted sales/total adjusted debt falls below 0.8x on a sustained basis Future Developments That May, Individually or Collectively, Lead to Positive Rating Action; - If the transaction takes place and after reviewing transaction information, the ratings may be affirmed with a Negative Outlook if net debt/adjusted inventory exceeds 50% over the next 12 months but Fitch expects the ratio to be sustained below 50% thereafter - if transaction does not take place, the ratings may be affirmed with a Stable Outlook LIQUIDITY Liquidity Likely to Remain Adequate: Fitch believes Sunac has sufficient cash to pay for the Wanda deal following strong contracted sales in 1H17, when its attributable contracted sales rose by 107% to CNY75 billion. This will materially increase its end-2016 cash balance of CNY69 billion by end-June 2017. 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 Kon Secondary Analyst Winnie Guo Associate Director +852 2263 9969 Committee Chairperson Kalai Pillay Senior Director +65 6796 7221 Summary of Financial Statement Adjustments - The CNY21 billion that Sunac has yet to pay for equity acquisitions is treated as debt - CNY10 billion in perpetual capital securities are treated as 100% debt Media Relations: Wai-Lun Wan, Hong Kong, Tel: +852 2263 9935, Email: wailun.wan@fitchratings.com. 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