Fitch Downgrades Jingrui to 'B-'; Outlook Negative
OREANDA-NEWS. Fitch Ratings has downgraded Jingrui Holdings Limited's (Jingrui) Long-Term Foreign-Currency Issuer Default Rating (IDR) to 'B-' from 'B'. The Outlook is Negative. Fitch has also downgraded Jingrui's senior unsecured rating and the ratings of all outstanding bonds to 'CCC+' from 'B', with Recovery Rating of 'RR5'.
The downgrade reflects the significant challenges the Chinese homebuilder faces in shifting its business focus to higher-tier cities. Its slower sales resulted in insufficient cash flow to support its high land replenishment cost. The company ended 2015 with low margin and tight liquidity, which has reduced rating headroom. The Outlook is Negative because a lack of financial discipline could easily push credit metrics beyond negative rating thresholds, and the company faces risks of policy tightening in its core cities.
Even at a moderate pace of land replenishment, Jingrui will remain FCF negative and leverage will remain high in the next 12-18 months, due to high land and interest costs. Fitch's rating case is for leverage of 65%-70% in 2016-2018.Although Jingrui does not face an imminent liquidity shortage, it will be reliant on capital market funding for its land acquisition as its liquidity position is only sufficient to meet its debt servicing needs.
The one-notch difference between the senior unsecured rating and the IDR reflects Fitch's expectations of lower recovery in the event of a default, which may be seen in the shift in the Recovery Rating to 'RR5', which represents below average recovery prospects, from 'RR4', which represents average recovery prospects.
KEY RATING DRIVERS
High Leverage to Persist: Jingrui's financial profile has deteriorated to an unsustainable level, with net debt/adjusted inventory climbing to 57% at end-2015 from 50% a year earlier. Land acquisition of CNY3.7bn so far in 2016 after CNY4.1bn of land purchases in 2015 has put further pressure on leverage and left it with almost no headroom for further expansion. Jingrui's land replenishment expenditure will keep Jingrui's leverage high because fierce competition in its core cities is driving up land prices. Housing demand picked up in these cities from the end of 2015, but deleveraging is only likely if there is a significant increase in ASP and land acquisitions slow down.
Sales Don't Support Land Investment: After Jingrui started to refocus in higher-tier cities in 2013, the company aggressively expanded its land bank in Shanghai, Hangzhou, Suzhou and Ningbo. Land payments and construction costs together amounted to 116% of contracted sales in 2013, 124% in 2014 and 99% in 2015. However, Jingrui's overall scale remained almost unchanged. The company's contracted sales has not met management's CNY10bn target for two years now, mainly due to slower turnover in lower-tier cities (mainly Shaoxing and Changzhou). The slower-than-expected contracted sales turnover has put pressure on its financial flexibility, which has also been squeezed by its large land replenishment cost.
Margin to Remain Under Pressure: Jingrui's EBITDA margin of -0.1% in 2015 was its worst ever as a big chunk of sales from low ASP projects in Tier 3 and 4 cities were recognised. The effect of the low prices for these projects will continue to linger through 2016. In addition, margin in 2016 will be under pressure due to sales of projects with lower margins in Suzhou, Hangzhou and Ningbo, which together accounted for 60% of contracted sales in 2015. Contracted sales from these cities in 2014 and 1H15 had gross margin of only 10%-20% due to their high land costs. ASPs have risen sharply in these three cities since 2H15, which could drive gross margin slowly towards 20% and beyond from 2017, although this improvement could be jeopardised if land acquisition costs sprint ahead of the ASP rise. The average cost of land acquired in Tier 1 and 2 cities increased 25% to CNY8,680 per square metre so far in 2016.
Policy Risks: Jingrui's operations are highly concentrated in the Yangtze River Delta, which leaves it vulnerable to policy and economic changes in the area. For instance, Shanghai at the end of March 2016 rolled out nine policies to curb activity in the housing market, including tightening home purchase criteria for non-local buyers, and tightening housing loan policies for buyers of second homes. The policies may dampen transaction volume, and pressure Jingrui's sell-through rate and ASP in Shanghai. The strong demand in Shanghai has spilled over nearby cities and driven up prices in Suzhou and Hangzhou from the end of 2015, which may spur these local governments to impose similar policy curbs in 2016.
Asset Quality Improving Gradually: Jingrui's land bank has gradually improved after it turned its focus to higher-tier cities to drive contracted sales growth. The company's total attributable land reserve by gross floor area (GFA) was 3.5 million square metres (sqm) at end-2015, of which 61% are located in Tier 1 and 2 cities. We expect Jingrui's turnover to gradually improve in 2016 because only 25% of its saleable resources by cost are in Tier 3 and 4 cities while ASP growth in Tier 2 cities has accelerated since the end of 2015.
Tight Liquidity; Refinancing Important: Jingrui's liquidity position is tight as its ratio of cash to short-term debt fell to 62% at end-2015 from 86% a year earlier. Jingrui's total cash of CNY3.6bn and undrawn credit facilities of CNY5bn at end-2015 are insufficient to cover its short-term borrowings (CNY5.8bn) and land acquisition costs. Jingrui's active fundraising in the onshore bond market has alleviated its refinancing pressure; it issued a CNY1.5bn five-year bond at 5.88% in March 2016. The issuance will bring down Jingrui's average borrowing cost from 9.68% at end-2015.
Fitch's key assumptions within the rating case for Jingrui include:
- Contracted sales GFA to be flat in 2016, but increase 5% in 2017 and 2018 due to improved churn in Tier 1 and 2 cities
- Contracted sales ASP to increase around 12% in 2016, 6%-8% in 2017 and 2018 due to price increases in Tier 1 and 2 cities in the Yangtze River Delta and Jingrui's shift to higher-tier cities
- Land premium of CNY4.1bn in 2016 with higher per sqm land costs due to the focus on higher-tier cities. Land purchases are executed in a prudent manner, with the ratio of land acquisition GFA to contracted sales GFA at 0.8x-1.0x
- Construction cost per sqm around CNY4,000-4,200 in 2016-2018
- Contracted sales/total debt around 0.8x-1.0x in 2016-2018
Negative: Future developments that may, individually or collectively, lead to negative rating action include:
- Net debt/ adjusted inventory sustained above 70% (2015: 57%)
- EBITDA margin sustained below 10% (2015: -0.1%)
- Cash / short-term debt sustained below 60%
- Deterioration in refinancing prospects that has significant adverse impact on its liquidity profile
The current rating is on Negative Outlook. Fitch does not anticipate developments with a material likelihood, individually or collectively, of leading to a rating upgrade. However, if the above factors do not materialise, then the Outlook may revert to Stable.
FULL LIST OF RATING ACTIONS
Jingrui Holdings Limited
Long Term Foreign-Currency IDR downgraded to 'B-' from 'B', Outlook Negative
Senior unsecured rating downgraded to 'CCC+' from 'B', with a Recovery Rating of 'RR5'
Rating on USD150m 13.625% senior unsecured bond due 2019 downgraded to 'CCC+' from 'B', with a Recovery Rating of 'RR5'
Rating on USD150m 13.25% senior unsecured bond due 2018 downgraded to 'CCC+' from 'B', with a Recovery Rating of 'RR5'