S&P: Yuzhou Outlook Revised To Positive On Robust Earnings Growth With High Profitability; 'B+' Ratings Affirmed
"We revised the outlook because we expect Yuzhou to rapidly expand its operating scale and materially minimize the gap in scale compared with its larger peers' over the next 12 months," said S&P Global Ratings credit analyst Brian Huang.
The company's high earnings reliance on a single province, Fujian, has constrained its credit profile. But we expect this to improve as Yuzhou establishes a meaningful presence outside its home market.
"We expect the company to maintain its above-average margins and financial discipline with a gradual improvement in leverage during its expansion," said Mr. Huang. The company has a track record of balancing growth and high profitability as it expands.
The affirmed ratings largely reflect the execution uncertainties Yuzhou still faces in some recently entered new markets. The company has identified four core markets outside Fujian as its focus in the next five years. While Yuzhou has established a strong foothold in Hefei, the company will take some time to establish market positons and demonstrate proven operating track records in other new markets, particularly Nanjing and Hangzhou.
We anticipate that Yuzhou's sales will increase significantly, to Chinese renminbi (RMB) 21 billion in 2016 and RMB25 billion in 2017, from RMB14 billion in 2015, given its ample salable resources. Its sales are set to approach the level of some larger peers, such as KWG Property Holding Ltd., with a similar sales target of RMB22 billion in 2016.
Yuzhou has increased its exposure to high-tier cities with greater demand. Over 7 million square meters in gross floor area or over 75% of its land bank is in Xiamen, Shanghai, Hefei, Nanjing, and Hangzhou. Partly thanks to the easy credit conditions in China, Yuzhou's sell-through rate improved to around 78% in the first half of this year, from 65% in 2015. Its sales increased by 116% to RMB16.8 billion for the first eight months of the year.
Yuzhou has also improved its geographical diversity, with sales from Fujian accounting for 46% in the first half this year, down from 59% in 2015 and 64% in 2014. Fujian's contribution to its total land bank has also been declining, to about 44% in June 2016, from 47% in 2015 and over 50% in the previous years.
We expect Yuzhou to maintain above-average profitability in the next two years, thanks to its sizable exposure to prime second-tier cities and lower-cost land parcels acquired in previous years. As of June 30, 2016, the company has over RMB20 billion in unrecognized revenue with a gross profit margin of over 32%. With higher land costs offsetting some price increases, we expect its gross margin in 2016 to decline slightly, but remain high at 32%-33%, compared with 35.8% in 2015.
In our view, Yuzhou will remain disciplined in its expansion. The company has increased its land acquisition costs this year to over RMB15 billion (about RMB10 billion in cash payment scheduled so far for 2016) to support its new markets in Hangzhou and Nanjing. However, the company will likely scale back its land acquisitions slightly in 2017. Rising cash receipts from sales should also help finance Yuzhou's higher land acquisitions. We estimate cash receipts will increase to RMB19 billion-RMB21 billion this year, from RMB13 billion in 2015. Our base case forecast is that Yuzhou's debt-to-EBITDA ratio will decline to marginally below 5x in 2016 and 2017, from 5.3x in 2015.
The positive outlook reflects our expectation that Yuzhou will experience strong sales growth over the next 12 months while materially diversifying its sales outside its home market and sustaining above-average margins. We also expect the company to maintain disciplined financial management, which would gradually improve its leverage.
We could raise the rating if Yuzhou expands its operating scale over the next 12 months and maintains high profitability similar to its current level while moderately reducing its leverage. A debt-to-EBITDA ratio of less than 5x on a sustained basis, with sales increasing notably above RMB21 billion over the same period would be a sign of such improvement.
We could revise the outlook to stable if Yuzhou fails to follow its strategy to significantly improve its operating scale and diversity while managing stable leverage. We could also revise the outlook if: (1) Yuzhou pursues land acquisitions more aggressively than we expect, such that its debt-to-EBITDA ratio stays above 5x on a sustained basis; or (2) the company fails to maintain its high profitability during its expansion, with EBTIDA margin declining to 30% or lower.