November 28, 2017 / 12:25 AM / 15 days ago

Fitch Rates China South City's USD Senior Notes Final 'B'

(The following statement was released by the rating agency) HONG KONG/SHANGHAI, November 27 (Fitch) Fitch Ratings has assigned China South City Holdings Limited's (CSC; B/Stable) USD300 million 7.25% senior notes due 2022 a final rating of 'B' 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 assignment of the final rating follows the receipt of documents conforming to information already received. The final rating is in line with the expected rating assigned on 13 November 2017. CSC's ratings are supported by well-located property 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 12% yoy in the financial year ended March 2017 (FY17) to HKD1.6 billion, driven mainly by growth in its outlet, property management service, and logistics and warehousing businesses. Fitch believes CSC's diversification will enhance internal cash flow and smooth out sales volatility. We expect non-development income/interest coverage to exceed 1.0x in the next year or two (FY17: 0.9x; FY16: 0.8x). Higher Leverage: CSC's leverage, measured by net debt/adjusted inventory, rose to 50.0% at end-March 2017 from 48.3% at end-March 2016, which is in line with our estimate. This is due to persistently high construction expenditure to build up saleable residential products and spending on investment properties. The company had 14.3 million square metres (sq m) of property under development and unsold completed properties, including investment properties, as at end-March 2017, compared with 14.2 million sq m a year earlier. Fitch expects leverage to remain between 50% and 60% for the next two to three years if CSC continues with our estimated capex of HKD8.5 billion-10 billion a year, taking into consideration the construction expenditure to build up saleable residential resources and faster land acquisition to replenish its residential land bank in Tier 2 cities, as well as investment on its non-development 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 30% yoy to HKD8.6 billion in FY17, buoyed by strong sales in three Tier 2 cities - Nanchang, Hefei and Nanning. Residential sales accounted for around 80% of total contracted value. Average selling prices decreased by 5.6% yoy over FY16 to HKD8,000 per sq m due to product-mix changes. Fitch expects contracted sales to reach HKD10 billion-11 billion in FY18 as residential markets in the Tier 2 cities where the company operates remain strong. 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 have withheld investment amid weaker economic growth, relocation demand has slowed, local governments have delayed 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 33.8% in FY17 amid low weighted-average land costs of CNY320 (HKD374) per sq m in FY17, a cut in selling and general expenses (-13% yoy), and larger recurring EBITDA from the non-development segment. A government subsidy also helped CSC maintain a healthy margin (FY17: HKD841 million; FY16: HKD1 billion). 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 as 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 at HKD10 billion-11 billion a year in FY18-FY19. - Non-development income to increase to HKD1.8 billion-2 billion in FY18. - Capital expenditure at HKD8.5 billion-10 billion per year in FY18-FY19. - Land replenishment ratio (land acquired/gross floor area presold) at 2x in FY18 RATING SENSITIVITIES Developments that may, individually or collectively, lead to negative rating action include: - EBITDA margin sustained below 20% (FY17: 33.8%; FY16: 32.5%); - Net debt/adjusted inventory sustained above 50% (FY17: 50.0%; FY16: 48.3%) if non-development income/interest is below 1.0x (FY17: 0.9x; FY16: 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 Adequate Liquidity: CSC had cash and cash equivalents, including restricted cash, of around HKD10.5 billion and unutilised banking facilities of HKD5.4 billion as at FYE17, covering short-term debt of HKD8.4 billion. CSC's successful issuance in the onshore bond market has also alleviated refinancing pressure and lowered its average borrowing cost to 6.2% at FYE17, from 6.3% at FYE16 and 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 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. 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