Fitch Ratings has assigned China South City Holdings Limited's (CSC; B/Stable) proposed US dollar senior notes a rating of 'B' and a Recovery Rating of 'RR4'.

The proposed notes are rated at the same level as CSC's senior unsecured rating because they will constitute its direct and senior unsecured obligations. CSC intends to use the net proceeds from the proposed notes to refinance existing debt.

KEY RATING DRIVERS

Residential Sales Support Performance: Fitch expects CSC to continue to rely on residential and multi-purpose properties in the next three years to provide cash flow for its land banking and construction needs, with trade-centre sales continuing to underperform in light of weak demand from SMEs. Contracted sales decreased by 8% yoy to HKD13.5 billion in the financial year ended March 2020 (FY20) amid the coronavirus pandemic. Residential and multi-purpose property sales altogether accounted for 80% of contracted sales in FY20. CSC has set its FY21 contracted sales target at HKD16 billion.

Stable Leverage: Fitch expects leverage - measured by net debt/adjusted inventory, including investment property at cost - to remain below 50.0% for the next three years if CSC maintains prudent land acquisitions and achieves satisfactory sales, as management plans. Leverage was largely stable at 43.6% in FY20 (FY19: 43.1%). Cash outflow for land acquisitions fell to HKD0.3 billion in FY20, from HKD1.6 billion in FY19. We estimate that CSC's total land premium will rise in FY21, at 10%-15% of sales proceeds.

Stabilising Development Margin: Fitch estimates that CSC's overall development margin will stabilise at around 40.0%. The company's gross profit margin for property development, including capitalised interest, improved to 44.2% in FY20, from 39.9% in FY19, due to a higher average selling price. Trade centres and residential units accounted for 12% and 82%, respectively, of development revenue in FY20.

Rising Non-Development EBITDA: Fitch expects CSC's non-development EBITDA interest coverage to rise, but to remain below 0.6x for the next three years. This will provide only limited support to the rating in the short term, although the diversification will enhance the company's cash flow. Income from CSC's non-development business increased by 4% yoy to HKD2.4 billion in FY20, driven by growth in its outlet, property management services and logistics and warehousing businesses. Non-development EBITDA interest coverage remained largely stable at 0.4x in FY20.

DERIVATION SUMMARY

CSC's eight projects are in tier one and two Chinese cities, which are better located than those of the other Fitch-rated trade-centre developer, Hydoo International Holding Limited (B-/Stable), whose 10-12 projects are mainly in tier three and four cities. This translates into better sales and EBITDA margins compared with Hydoo and other competitors in the industry. CSC generated HKD13.5 billion in contracted sales in FY20, compared with Hydoo's CNY3.0 billion in 2019.

CSC generated HKD2.4 billion in non-development income in FY20. The non-development segment is still small in terms of EBITDA generation, but may be able to support debt interest service in coming years. CSC's leverage of 43.6%, measured by net debt/adjusted inventory (including investment property at cost) in FY20 was comparable with that of other 'B' rated peers.

KEY ASSUMPTIONS

Property development contracted sales to reach HKD14 billion-17 billion in FY21-FY23

EBITDA margin, excluding capitalised interest and government grants, sustained above 25% in FY21-FY23 (FY20: 33%)

Non-development income to increase by 10%-15% per year in FY21-FY23, with EBITDA margin of around 40%

Construction and land acquisition cash outflow to account for 50%-60% of sales proceeds in FY21-FY23 (FY20: 50%)

No changes in Recovery Rating assumptions from the rating action commentary published on 18 December 2019.

RATING SENSITIVITIES

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

Non-development EBITDA/cash interest expense sustained above 0.6x (FY20: 0.4x)

Net debt/adjusted inventory (including investment property at cost) sustained below 40%

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

EBITDA margin sustained below 20%

Net debt/adjusted inventory (including investment property at cost) sustained above 50%

Deterioration in liquidity or difficulty in debt refinancing

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

Tight but Manageable Liquidity: CSC had cash and cash equivalents of around HKD10.3 billion, including restricted cash and pledged time deposits of HKD6.5 billion, as at end-March 2020. It also had uncommitted bank facilities of HKD17.2 billion, covering short-term debt of HKD14.9 billion.

Fitch treats the puttable date of CSC's onshore bonds as the effective maturity date and includes all redeemed offshore debt as maturing in the next financial year. The put options were not exercised for the onshore bonds puttable in August 2020. In June 2020, CSC issued an additional USD125 million by tapping its USD225 million 10.875% senior notes due 2022. In August 2020, CSC also issued USD200 million 364-day 11.5% senior notes due 2021, and repaid the USD250 million 10.875% senior notes due August 2020.

DATE OF RELEVANT COMMITTEE

17 December 2019

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.

RATING ACTIONS

ENTITY/DEBT	RATING	RECOVERY

China South City Holdings Limited

senior unsecured

LT	B 	New Rating	RR4

VIEW ADDITIONAL RATING DETAILS

Additional information is available on www.fitchratings.com

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