Published on 29 April 2016
RAM Ratings has revised the outlook on the AA3(s) issue rating of Country Garden Real Estate Sdn Bhd (CGRE), to negative from stable. This follows an unexpected spike in the debt load of Country Garden Holdings Company Limited (Country Garden or the Group) in 2H 2015 for land purchases that represented a significant deviation from management’s guided level, thereby leading to a deterioration in the Group’s financial metrics.
Contrary to our previous expectation that its growth will take a more measured approach, Country Garden is now ramping up its pace of expansion which will be fuelled by a boost in property launches following aggressive land acquisitions in 2015. Significantly, the Group is shifting more of its focus onto property projects in tier-1 and tier-2 cities in China. About 75% of the enlarged land purchases in 2015 and the bulk of its new project launches this year are in those cities. This stronger push into tier-1 and tier-2 cities remains in line with Country Garden’s efforts to achieve a more balanced property portfolio overall and its diversification into those cities has shown some level of success. Nevertheless, the negative outlook reflects RAM’s concerns that the Group’s financial metrics may not recover sufficiently in the near term amid elevated debts and lower operating margins.
As at end-December 2015, Country Garden’s adjusted net gearing ratio swelled to 0.92 times – far exceeding our previous expectation of about 0.6 times. Country Garden’s debts rose unexpectedly in 2H 2015 due to land acquisitions, bringing its total cash outlay for land-banking to RMB37 billion last year – nearly double its budgeted RM20 billion. Together with RMB16.5 billion of perpetual capital securities raised in December for an acquisition that had fallen through, the Group’s debt burden surged RMB45 billion (+70% y-o-y) to RMB109.3 billion. This debt level exceeded substantially our expectation and was a departure from our understanding that greater financial discipline had been instilled. Meanwhile, Country Garden’s operating cashflow debt cover (OCFDC) slid to 0.24 times in 2015 (projected: at least 0.3 times), despite having met its targeted contracted sales. As the Group has committed to a still-high level of land purchases, the recovery of its financial metrics in the near term could be challenging amid elevated debts.
The Group achieved RMB140.2 billion of contracted sales in 2015 (+7% y-o-y), of which 52% stemmed from tier-1 and tier-2 cities – underlining some traction in its strategy to diversify into these cities. Encouraging contracted sales of RMB42.9 billion had been achieved in the first 3 months of this year, in view of the Group’s targeted growth in contracted domestic sales of to RMB168 billion (+20%) for 2016. Expansion this year will be supported by saleable resources of a large RMB300 billion, the bulk of which will stem from tier-1 and tier-2 cities. However, risks could heighten given a potentially longer cash cycle, different regulatory and business practices, as well as customer preferences especially in newly entered tier-1 and tier-2 cities. We are also mindful of the impact of cooling measure on tier-1 and tier-2 cities given the phenomenal rise in prices in some. Moreover, debt-funded land acquisitions will reduce its flexibility to defer launches if the market softens.
Although Country Garden’s revenue climbed up 34% y-o-y to RMB113.2 billion in fiscal 2015, its margins continued to slip. The Group’s margin on operating profit before depreciation, interest, and tax thinned to 13.8% in fiscal 2015 (fiscal 2014: 17.9%), chiefly because some properties sold in 2014 at reduced prices amid cooling initiatives had been booked. Despite a more aggressive move into tier-1 and tier-2 cities where prices in general are still improving, we do not foresee significant profitability improvement in the near term; the benefit of better selling prices in those cities may be largely offset by more expensive land. With improved average selling prices, we understand that the overall gross profit margin on contracted sales secured in 1Q 2016 had come in at about 25%. Meanwhile, the Group’s pre-tax profit unexpectedly dipped to RMB14.8 billion in fiscal 2015 (fiscal 2014: RMB16.4 billion), dragged down by sizeable forex losses on its borrowings.
Notwithstanding the above weaknesses, Country Garden’s ratings continue to be supported by its position as a large-scale and entrenched Chinese property player, its integrated business model, and its fairly diversified geographical footprint with minimal project-concentration risk.
The rating outlook on CGRE could be reverted to stable if the Group’s OCFDC recovers to a sustainable minimum of 0.3 times and its adjusted net gearing ratio eases to 0.7 times or lower. To meet these thresholds, Country Garden may have to noticeably improve further its operating cash cycle even if its sales targets are met. The Group will also have to demonstrate sufficient financial discipline in its debt-funded land acquisition.
The issue rating reflects unconditional and irrevocable corporate guarantees extended by Country Garden, Bright Start Group Limited and Top Favour Holdings Limited, on a joint and several basis to CGRE’s to Islamic Medium-Term Notes Programme of RM1.5 billion in Nominal Value (2015/2035). Therefore, the issue rating reflects the credit linkage to Country Garden (as the strongest obligor) and the credit fundamentals of the Group.
Peter Kong, CFA
(603) 7628 1029
Peter Kong, CFA
(603) 7628 1029