Fitch Rates Xinyuan's Proposed USD Notes 'B(EXP)'
The notes are rated at the same level as Xinyuan's senior unsecured rating because they constitute direct and senior unsecured obligations of the company. The final rating is subject to the receipt of final documentation conforming to information already received.
The Chinese homebuilder's ratings are supported by its strong contracted sales and moderate margin recovery. The ratings are constrained by its low land-bank business model, high leverage driven by land replenishment needs, and tight but sustainable liquidity.
KEY RATING DRIVERS
Solid Contracted Sales: Xinyuan's strong contracted sales in 2015 and 1H16 were mainly driven by robust market sentiment in its core Tier 2 and satellite cities surrounding Tier 1 cities, namely Zhengzhou, Jinan, Suzhou and Kunshan. Tier 2 cities contributed 61% and 62% of contracted sales in 1H16 and 2015, respectively.
Small Land Bank Constrains Ratings: Xinyuan's total sellable gross floor area (GFA) increased to 2.56 million square metres (sqm) in China and the US at end-June 2016, from 2.33 million sqm at end-2015. Its land bank will last 2 years, based on 2016 expected sales, which remains low compared with that of 'B'-rated peers. Apart from normal public auctions, Xinyuan pays advance deposits to local government or industry partners to secure a large part of its future land bank. There is greater uncertainty about its land bank as a result of this acquisition strategy, which continues to constrain scale and sales.
Land Replenishment Pressuring Leverage: Xinyuan has accelerated acquisitions after not purchasing any new land in 2015. So far in 2016, it announced acquisitions of CNY3.6bn of sites in China and the US, with cash outlay of around CNY2.6bn after considering returned land deposits and prepayments for certain land parcels.
With its low land bank and fast asset-churn model, Xinyuan's high land replenishment needs will continue to pressure leverage. Fitch expects leverage to hover around 45%-50% in 2016-2017, in view of surging land prices in higher-tier cities amid fierce competition and a moderate acquisition pace with cash-land-premium-paid/contracted-sales at 40%-45%.
Expect Margin Recovery: Fitch expects Xinyuan's gross margin to recover in 2H16-1H17, in line with surging average selling prices in its core cities and recognition of the Oosten project in US. This follows a slight decline to 27% in 1H16, after adding back capitalised interest, from 28% in 2015, due to recognition of low-margin projects in Suzhou, Jinan and Kunshan. The homebuilder's EBITDA margin improved to 15.2% in 1H16, from 14.7% in 2015, due to management's continued efforts to reduce selling, general and administration costs. However, the improvement in Xinyuan's gross margin could be jeopardised from 2H17 if land acquisition costs sprint ahead of the rising average selling price.
Tight But Sustainable Liquidity: The company's liquidity position is stable with a ratio of cash to short-term debt of 90% at end-June 2016 compared to 92% at end-2015. Xinyuan's total cash of USD931m and undrawn credit facilities of USD306m at end-June 2016 are insufficient to cover its short-term borrowings of USD1.036bn and acquisition costs. Xinyuan's active fundraising in the onshore bond market has alleviated its refinancing pressure. The company issued two five-year bonds of USD107m and USD77m at 7.47% and 7.09% in 2016. These issuances have brought down Xinyuan's average borrowing cost to 8.5% at end-June 2016 from 9.5% at end-2015.
Fitch's key assumptions within our rating case for the issuer include:
- Contracted sales GFA to increase 40%-50% in 2016 and 5% in 2017-2018 due to improved churn in Tier 1 and Tier 2 cities
- Contracted sales ASP to increase around 5% between 2016 and 2018 due to price increases in Tier 1 and Tier 2 cities
- Moderate acquisition pace with cash-land-premium-paid/contracted-sales at 40%-45% in 2016-2018
- Construction cost per sqm declining to around USD650-700 in 2016-2018, due to cheaper construction cost in Tier 2 cities
- Selling, general and administrative costs as percentage of contracted sales will gradually decrease to between 12%-13% as Xinyuan plans to cut internal costs
Future developments that may, individually or collectively, lead to negative rating action include:
- Net debt/adjusted inventory rising above 60% on a sustained basis
- Contracted sales/total debt falling below 0.6x on a sustained basis (last 12 months to June 2016: 0.8x)
- EBITDA margin falling below 15% on a sustained basis
Future developments that may, individually or collectively, lead to positive rating action include:
- Significant increase in scale, as reflected by contracted sales exceeding CNY15bn
- Net debt/adjusted inventory sustained below 40%
- Contracted sales/total debt improving to above 1.0x on a sustained basis
- EBITDA margin improving to above 20% on a sustained basis