Fitch Ratings has affirmed China Overseas Grand Oceans Group Ltd's (COGO) Long-Term Issuer Default Rating (IDR) at 'BBB' with a Stable Outlook.

Fitch has also affirmed COGO's foreign-currency senior unsecured rating and the rating on the outstanding notes it guarantees at 'BBB'.

COGO is rated top-down at one notch below the 'bbb+' Standalone Credit Profile (SCP) of its parent, China Overseas Land & Investment Limited (COLI, A-/Stable). We do not expect support from COLI's ultimate parent, state-owned China State Construction Engineering Corporation Ltd (A/Stable), to flow through to COGO due to its limited scale and importance to China's housing objectives.

COGO's SCP of 'bb' is supported by its solid market position, robust leverage and strong financial flexibility, but is constrained by its below-peer sales.

Key Rating Drivers

Strong Parent Supports Rating: We believe COLI has 'High' operational, 'Medium' strategic and 'Low' legal incentives to support COGO. COGO is operationally integral to COLI's core property-development business. COLI continues to expand its footprint in Tier 1 and 2 cities, while COGO, which shares the same brand, focuses on strong Tier 3 and 4 cities. COGO's presence in lower-tier cities is integral to COLI's position as a nationwide homebuilder. However, COGO's financial contribution to COLI is small and COGO has limited legal ties with COLI, such as guarantees or cross-defaults.

Steady Sales Recovery: COGO's sales fell by 43% in 2022, below the 28% decrease of the overall market. We believe this stems from its focus on lower-tier cities with less robust demand. Sales were also hit by the Covid-19 lockdown in 1H22 in the Yangzte River Delta, one of its major operating regions. We expect sales to grow 15% yoy in 2023, with CNY3.5 billion monthly in June to December, similar to the 2022 level. COGO reported yoy sales growth of 35% in 5M23, much better than the market's 8%, in part driven by a sharp but temporary rebound in February and March 2023.

Weaker Markets but Strong Position: We believe COGO retains a strong competitive position and can benefit from a recovery in markets in China's lower-tier cities, despite the potentially weaker demographic and economic prospects of these cities. COGO ranked top three in sales in 18 out of the 40 cities where it operates.

Moderate Rise in Leverage: COGO's leverage, measured by net debt/net property assets, rose to 36% in 2022, from about 30% in 2021. We expect leverage to decline slightly in 2023, based on our expectation of double-digit sales growth, while land acquisition expenditure is largely similar to the reduced levels in 2022. COGO spent only CNY1.5 billion of total land premiums in 5M23, 7% of total contracted sales over the period.

Management said COGO continues to be active in the land bidding process but did not secure many projects in 5M23, as some of the cities it operates in had very competitive land auctions, some of which were settled via a lottery allocation system.

HIBOR Hike Raised Funding Costs: COGO's reported weighted-average interest rate rose to 4.8% as of end-2022, from 3.8% a year ago. The increase was mainly attributable to an increase in the Hong Kong Interbank Offered Rate (HIBOR) to 6.3% by end-2022 from 2.0% at end-2021, and was partly offset by a fall in the cost of yuan loans to 4.4% by end-2022, from 4.8% at end-2021. About 30% of COGO's debt is floating-rate Hong Kong dollar loans, and management plans to reduce the exposure over the next two to three years by replacing it with Chinese yuan loans.

Our rating case assumes COGO will refinance part of its Hong Kong dollar floating-rate debt with onshore borrowings and reduce exposure to Hong Kong dollar floating-rate debt to 20% over the next three years. We refer to movements in the US dollar policy rate based on Fitch's Global Economic Outlook, to forecast the borrowing cost of COGO's HIBOR-based bank loans. We expect the average interest rate to increase by about 40bp in 2023 and fall by 45bp in 2024.

Profitability to Bottom Out: COGO's gross profit margin (GPM) fell by 8.6pp to 14.4% in 2022, from 23.0% in 2021, due to weaker selling prices that pressured project profitability and inventory write-downs (CNY2.7 billion booked under cost of goods sold). The impairment accounted for about 2% of gross property-development inventory reported at end-2022. The GPM would have been 19% in 2022, excluding the impairment. We expect margins to bottom out from 2023 as the company follows internal guidelines for land acquisition based on more conservative selling price assumptions in recent years.

Derivation Summary

COGO's IDR is one notch below the 'bbb+' SCP of its parent, COLI. COGO's SCP is constrained by the scale of its attributable sales, which is smaller than that of 'bb' rated peers.

We estimate that COGO's attributable sales in 2022 was about CNY34 billion, smaller than the CNY80 billion of China Jinmao Holdings Group Limited (BBB-/Stable, SCP: bb+) and Yuexiu Property Company Limited (BBB-/Stable, SCP: bb). It was, however, comparable with that of Beijing Capital Development Holding (Group) Co., Ltd. (BBB/Stable, SCP: bb) and larger than Beijing Capital City Development Group Co., Ltd.'s (BBB/Negative, SCP: bb) of about CNY20 billion. On the other hand, COGO's leverage and balance-sheet transparency are better than that of most peers with 'bb' category SCP.

Key Assumptions

Fitch's Key Assumptions Within Our Rating Case for the Issuer:

Total contracted sales to increase by 15% in 2023 (5M23: 35%), based on strong recovery in 5M23 from a low base in 2022, and flat sales in 2024;

Cash collection rate to remain strong at more than 95% in 2023 and 2024 (2022: 113%);

Land gross floor area acquired/gross floor area sold at 0.6x in 2023 and 1.0x in 2024 (2022: 0.6x);

Construction expenditure to account for 55% of sales in 2023 and 50% in 2024;

Weighted-average interest rate to increase by 40bp in 2023 and decrease by 45bp in 2024, based on Fitch's forecast of US dollar policy rate movements and our expectation that Hong Kong dollar-denominated floating-rate debt will fall to 20% of COGO's debt over the next three years, from the 30% at end-2022.

Dividend pay-out ratio of 20% in 2023 and 2024 (2022: 21%).

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to positive rating action/upgrade:

A perceived strengthening of incentives for COLI to support COGO.

Factors that could, individually or collectively, lead to negative rating action/downgrade:

A perceived weakening of incentives for COLI to support COGO.

A lowering of COLI's SCP.

For COLI's SCP, the following sensitivities were outlined by Fitch in a Rating Action Commentary on 5 July 2023:

Factors that could, individually or collectively, lead to positive rating action/upgrade:

Positive rating action is not expected over the next 12 to 18 months due to the high cyclicality and regulatory risks in China's property sector.

Factors that could, individually or collectively, lead to negative rating action/downgrade:

Deterioration in COLI's net debt/net property assets to above 35% over a sustained period could lead to a lower SCP.

Best/Worst Case Rating Scenario

International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.

Liquidity and Debt Structure

Sufficient Liquidity: COGO had unrestricted cash of CNY19.4 billion and restricted cash, including regulated pre-sale proceeds, of CNY9.9 billion at end-2022, against short-term debt of CNY12.2 billion. About 85% to 90% of the company's total debt is from bank loans, which we believe have lower refinancing risk than trust loans and capital market debt. COGO's reported weighted-average funding cost rose to 4.8% in 2022, from 3.8% in 2021, due to a hike in HIBOR and COGO's high exposure to Hong Kong dollar-denominated floating-rate debt.

Issuer Profile

COGO is a mid-sized Chinese developer with a leading position in lower-tier cities. The company ranked within the top-three developers by 2022 sales in 18 of the 40 cities in which it operates.

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

ESG Considerations

Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg

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