Fitch Ratings has assigned China-based Yuzhou Group Holdings Company Limited's (BB-/Stable) proposed US dollar senior notes a 'BB-' rating.
The proposed notes are rated at the same level as Yuzhou's senior unsecured rating because they constitute its direct and senior unsecured obligations. Yuzhou intends to use the net proceeds from the issue primarily to refinance its existing debt.
Yuzhou's ratings are supported by its low leverage and improving land-bank quality. Its profitability is healthy with an EBITDA margin of above 25%. The ratings are constrained by its relatively small attributable contracted sales and revenue scale. The company's sales expansion and relatively short land-bank life of around 2.5 years will pose a challenge to its ability to keep leverage at the current low level.
KEY RATING DRIVERS
Low Leverage: Fitch estimates Yuzhou will keep leverage, defined by net debt/adjusted inventory, including proportional consolidation of joint ventures and associates, below 45% over 2020-2024 as the company will spend no more than 50% of consolidated contracted sales on acquiring land. Leverage was well below 40%, the level at which Fitch will consider positive rating action, in the past four years. Leverage fell to 30.1% by end-2019 as Yuzhou slowed land acquisitions.
The company reduced loan guarantees to JVs and associates in 1H20, which pushed down consolidated leverage with guarantees to below 40% in 1H20 from 45% at end-2019.
Relatively Small Land Bank: Fitch estimates Yuzhou had unsold attributable land bank of 13.7 million square metres (sqm) at end-1H20, sufficient for around 2.5 years of development. We believe the company needs to continuously replenish land to sustain contracted sales growth, which will limit its ability to keep land costs low and leverage at current levels, especially as it buys more parcels in Tier 2 cities, where competition among developers is more intense. Fitch forecasts Yuzhou will keep its land-bank life at current levels, as it believes a larger land bank limits its flexibility to manage policy uncertainties.
Scale Smaller than Peers: Yuzhou's 2019 attributable contracted sales were at the lower end of the range of that of 'BB-' peers. Its 2019 attributable contracted sales rose 24% to CNY45 billion, driven by floor area sold. Yuzhou's growth was slower than peers' prior to 2019, which kept its leverage lower. The company has reached its 2020 target of CNY100 billion in total contracted sales as of 7 December 2020. Total contracted sales in 11M20 rose by 47% yoy, well above the high-single-digit sales growth achieved by the industry.
Evolving Group Structure: Yuzhou's implied cash collection (the change in customer deposits plus revenue booked during the year) in 2019 was only CNY17.4 billion, or 39% of reported attributable sales, down from 74% in 2018. Its 2019 property sales revenue also fell 5% despite a 24% rise in attributable contracted sales. This suggests that a large portion of Yuzhou's contracted sales and revenue in 2019 came from its JVs and associates. A big share of land was acquired via JVs and associates before 2019, but a larger share in the past 12 months were made on balance sheet.
The high proportion of off-balance-sheet projects means the performance of many projects are not fully reflected in the company's financials, in Fitch's view. However, Fitch believes Yuzhou's financials will gradually reflect the overall performance of projects as a large percentage of recently acquired land is included in the consolidated balance sheet. This transition may lead to short-term volatility in the company's financial metrics, before stabilising.
Improving Land-Bank Quality: More than 95% of Yuzhou's land acquired in 2019 was in Tier 1 and 2 cities. It led to high acquired land cost of CNY10,023/sqm in 2019. This should translate to better average selling prices (ASP) in the coming two years. We expect its ASP to rise 7% per year on average in 2021-2023 from CNY16,391/sqm in 11M20.
Healthy Margin: Fitch expects Yuzhou's EBITDA margin to stay above 25% in 2020-2024. EBITDA margin fell to 27.6% in 2019 from 32.1% in 2018, as Yuzhou disposed of some low-margin projects. Margin will improve as the company had unrecognised contracted sales that carry gross profit margin of more than 25% and will be recognised over the next two to three years. Selling and administrative expenses rose to 7.8% of revenue in 2019 from 4.5% in 2018. Fitch expects this ratio to drop as the group's revenue increases, which will support the EBITDA margin.
Nation-Wide Operations: Yuzhou's land bank is spread over the Yangtze River Delta, West Strait Economic Zone (cities on the west coast of the Taiwan Strait), Bohai Rim, Greater Bay Area, central and south-western China. Sales in the Yangtze River Delta accounted for 65% of Yuzhou's contracted sales in 2019 and will continue to be its key development region in the coming three years. It was among the top five developers in Suzhou and Hefei in 2019 in terms of sales.
DERIVATION SUMMARY
Yuzhou's proportionally consolidated leverage is low compared to that of most 'BB-' peers. Yuzhou's non-controlling interests (NCI) as a percentage of its equity is also lower than peers', which means the company has more financial flexibility to dispose of stakes in projects to reduce leverage.
Yuzhou's main rating constraint is its contracted sales and revenue scale, which is smaller than most 'BB-' peers. Its closest peer is KWG Group Holdings Limited (BB-/Stable), whose 2019 attributable contracted sales was CNY10 billion more than that of Yuzhou. However, the revenues of the two companies were similar. KWG has a slower churn model than Yuzhou, which explains its wider EBITDA margin. KWG's 2019 leverage was higher than that of Yuzhou, but KWG has a longer land-bank life and better land-bank quality, which gives it more room to deleverage.
KEY ASSUMPTIONS
Fitch's Key Assumptions Within Our Rating Case for the Issuer
- Attributable contracted sales of CNY55 billion-67 billion a year in 2020-2024 (2019: CNY45 billion)
ASP to rise 7% per year on average in 2021-2023 from CNY16,391/sq m in 11M20
Land bank life maintained at around 2.5 years
Up to a 2% rise each year in average land costs in 2021-2024 (2019: CNY10,023/square metre)
Gross floor area acquired at 0.9x-1.1x of that sold in 2020-2024
Selling, general and administrative expense at 4.0%-4.3% of contracted sales in 2020-2024
RATING SENSITIVITIES
Factors that could, individually or collectively, lead to positive rating action/upgrade:
Proportionally consolidated net debt/adjusted inventory sustained below 40%
Attributable contracted sales and revenue scale comparable to that of 'BB' rated peers
No decrease in land bank life (defined by saleable land bank as of year-end divided by expected gross floor area sold in the next year)
Factors that could, individually or collectively, lead to negative rating action/downgrade:
Proportionally consolidated net debt/adjusted inventory above 50% for a sustained period
EBITDA margin below 20% for a sustained period
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
Abundant Liquidity: Yuzhou had a total cash balance of CNY43.0 billion, including restricted cash of CNY2.3 billion and CNY5.7 billion of non-pledged time deposits, as of end-1H20. Its available cash, excluding restricted cash and non-pledged time deposits, was 1.6x its CNY22.3 billion debt maturing within a year. The company has diversified funding channels to ensure the sustainability of its liquidity, including bank loans, onshore and offshore bond issuance, as well as equity placements.
DATE OF RELEVANT COMMITTEE
08 September 2020
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
RATING ACTIONS
ENTITY/DEBT RATING
Yuzhou Group Holdings Company Limited
senior unsecured
LT BB- New Rating
VIEW ADDITIONAL RATING DETAILS
Additional information is available on www.fitchratings.com
YUZHOU GROUP HOLDINGS COMPANY LIMITED 
