Fitch Downgrades Wuzhou's Ratings to 'CCC' from 'B-'
The downgrade reflects the sustained weakening of Wuzhou's financial position as demand for its main trade centre product remained weak amid poor business sentiment among SMEs. Wuzhou's adjusted inventory increased by CNY643m to CNY13.8bn in the 12 months to end-June 2016, but net debt rose by a much larger CNY1.7bn to CNY5.7bn over the same period. This reflects the large cash drain given its high selling, general and administrative (SG&A) costs and interest expenses. This has increased the refinancing risk for its capital market debts that fall due from 2018.
KEY RATING DRIVERS
Continued Weak Sales: Wuzhou's contracted sales fell 32% yoy to CNY2.2bn in 1H16, after declining 9% to CNY6bn in 2015, which was lower than its target of CNY7bn and our estimate of CNY6.8bn, amid the difficult operating environment. Fitch believes contracted sales will remain weak at CNY4bn-4.5bn a year in 2016-2017, given sluggish demand from SMEs for trade centres, and lower investor appetite for commercial properties.
Poor Cash Collection: Fitch believes that Wuzhou's cash collection rate will not rise until China's business environment improves over a sustained period and eases the cash flow positions of its customers, which are mostly SMEs. Wuzhou's cash collection rate was low at 60% in 2015 and 1H16, dropping from 67% in 2014 and above 80% before 2014. Wuzhou offers some of its customers deferred payment terms where 30%-50% of the sales will be collected only upon completion, which is usually 12-18 months after the contracted sales are booked. This means the company has to incur more development expenditure even as its sales performance remains weak.
Price Cuts Not Effective: Wuzhou was the first among its peers to reduce prices in the weak market, but sales have not improved. Furthermore, its EBITDA margin fell below zero to -3.5% in 2015 and -2.2% in the 12 months to June 2016, as a result of the price cuts. Destocking has been slow because most of Wuzhou's projects are located in third-tier and lower-tier cities, and Fitch expects the sell-through ratio to be low at 45%-50% in the next two to three years.
Leverage Continues to Worsen: Fitch expects Wuzhou's leverage, as measured by net debt/adjusted inventory, to reach 40% in 2016 (1H16: 41.4%) and continue rising to above 50% from 2017. This will be driven by its weak operation and high interest and SG&A expenses, which will represent more than 30% of contracted sales value (2015: 26%, 1H16: 31%) in the next two to three years, though the company was able to reduce SG&A expenses last year. Furthermore, Wuzhou needs to finance construction activities, which will form 65% to 75% of contracted sales value in the next two to three years based on our forecast; while the company's low cash collection ratio means it will continue to rely on external funding to cover its operational cash shortfall.
Fitch expects Wuzhou to continue with large construction capex to complete construction of pre-sold projects, which could bring in more cash as customers make payments, and to launch new projects for sale. Wuzhou's ability to secure refinancing for its onshore and offshore bonds is at risk until the company's operational cash flows improve and its financial profile strengthens.
No Imminent Liquidity Risk: Wuzhou's cash, including pledged deposits, totalled CNY3.1bn at end-June 2016. This is not materially lower than its CNY3.5bn in short-term debt (CNY4.1bn, including a convertible bond with put option that may be exercised from September 2017). It issued a CNY500m three-year private bond out of its CNY4bn quota at 6.9% in August 2016 to further improve its liquidity position. Wuzhou in January 2016 obtained approval to issue up to CNY1.6bn of onshore public bonds, but has not yet done so.
Fitch's key assumptions within the rating case for the issuer include
- Contracted sales to be CNY4bn-4.5bn a year in 2016-2017
- Land replenishment rate, as measured by land acquired over contracted sales sold by gross floor area, at 1.1x-1.2x in 2017-2018
- Construction cost / contracted sales at 65%-75% in 2016-2018
- Gross profit margin at around 25% in 2016-2018
- Cash collection ratio at 60% in 2016-2018
Negative: Future developments that may, individually or collectively, lead to negative rating action include:
- Further weakening of liquidity position
Positive: Developments that may, individually or collectively, lead to positive rating action include:
- Sustained improvement in sales and cash collection
- Contracted sales/gross debt is sustained above 1x (12 months to end-June 2016: 0.56x; 2015: 1.04x)
- Net debt/adjusted inventory is sustained below 40%