Fitch Ratings has assigned China-based homebuilder Zhongliang Holdings Group Company Limited's (B+/Stable) proposed US dollar bonds a rating of 'B+', with a Recovery Rating of 'RR4'.
The proposed notes are rated at the same level as Zhongliang's senior unsecured rating because they will constitute its direct and senior unsecured obligations.
Zhongliang's ratings are underpinned by its contracted sales scale, which is comparable with 'BB' category homebuilders. The group's projects spread across five core economic regions in China, mitigating regional economic and policy risks. Zhongliang adopts an ultra-fast-churn model and aims to begin sales soon after acquiring land, leading to a low net inventory base. This, together with guarantees to joint ventures (JV) and associates, could increase the volatility of the company's financial profile and is a constraint on Zhongliang's ratings.
KEY RATING DRIVERS
Geographically Diversified Homebuilder: Zhongliang's property projects were located in more than 100 cities across five core economic regions in China as of end-1H20. The majority were in third- and fourth-tier cities, which have weaker demand fundamentals than higher-tier cities. Zhongliang is responsive to changing market conditions and has increased its presence in second-tier cities in the past 18 months; 64% of the land it acquired in 1H20 was in tier-two cities. The improved diversification mitigates regional economic and policy shocks.
Strong Growth: Fitch expects attributable contracted sales to continue to rise, after increasing to CNY99 billion in 2019 from CNY16 billion in 2016, to help the company become one of China's top-20 property developers. Zhongliang's standardised operational procedures, which cover its entire property-development value chain - including land acquisition, marketing, design and product lines - have aided its rapid expansion. Its improving land bank quality is evident from its average selling price of CNY12,500/square metre (sq m) in 1H20, up from CNY10,300/sqm in 2019.
Low Margin to Edge Higher: Fitch expects its EBITDA margin to edge up to around 20%-22% in the coming four years, from 18% as of end-2019. This is aided by improving selling, general and administrative expenses by streamlining internal structures and economies of scale. Its earned but not booked development-property revenue carries 22%-25% gross profit margin.
Low Net Inventory: Zhongliang's ultra-fast-churn model allows for sound capital utilisation. It enters the pre-sale phase quickly after land is acquired. Projects are small and aimed at the mass market, enabling it to de-stock and achieve positive cash flow generation within a short period. Internally generated cash flow supports capital needs for land acquisition and development, reducing the need for large debt funding. Zhongliang's higher-than-peer contracted liabilities as a proportion of inventory results in a low net inventory base against its peers. Still, Zhongliang's gross inventory is in line with higher-rated peers.
Leverage May Increase: Fitch believes continued growth in scale amid a moderating property market may increase pressure to replenish land, leading to volatile land acquisition expenditure. This may result in swings in leverage, especially if contracted sales slow significantly. Zhongliang's leverage - measured by net debt/adjusted inventory with proportional consolidation of JVs and associates - was a low 27% at end-2019 and around 33% at end-1H20. Fitch expects leverage to increase to around 40% in the next few years, but this depends on Zhongliang balancing fast-churn contracted sales and land acquisitions.
Fitch estimates the unsold attributable land bank at end-1H20 was sufficient for around 2.5-3 years of development and expects Zhongliang to maintain land bank life at similar levels in the near term.
JV Guarantees: Zhongliang provides guarantees to its JVs and associates, which totalled CNY8.5 billion at end-1H20 and were large relative to consolidated net debt of CNY17.8 billion. We assess Zhongliang based on proportionate consolidation; however, if we were to measure leverage based on consolidated net debt and guarantees/consolidated adjusted leverage, it would have been 67% at end-2019 and 63% at end 1H20 - higher than that of most 'B+' rated peers. This difference is due to low net leverage at JVs and associates. We expect the gap to narrow, as the company plans to lower its guarantees.
Minority Shareholders: Fitch expects non-controlling interests as percentage of Zhongliang's equity to edge down in the medium term; total non-controlling interests in the company's balance sheet accounted for 65% of total equity at end-1H20, which was higher than that of 'B+' peers. This reflects Zhongliang's reliance on cash from contracted sales and capital contributions from non-controlling shareholders, which are mainly developers, as a source of financing to expand scale. This lowers Zhongliang's need for debt funding, but creates potential cash leakage.
DERIVATION SUMMARY
Zhongliang's attributable contracted sales are at the high-end of the 'B+' peer range in terms of scale. Its land bank is also spread more widely across China's core economic regions than that of peers, such as Hong Kong JunFa Property Company Limited (B+/Stable). However, more than 70% of Zhongliang's gross floor area is in tier three and four cities (55% if it is in terms of saleable value), which we believe have less resilient demand than first- and second-tier cities. Zhongliang's land bank quality is also slightly weaker than that of 'B+' rated peers, with an average selling price of CNY10,300/sqm in 2019.
We estimate that Zhongliang's unsold attributable land bank at end-2019 was equivalent to around 2.8 years of gross floor area sold - shorter than that of fast-churn peers such as Risesun Real Estate Development Co.,Ltd. (BB-/Stable) - with a land bank life of 3.5 years. This pressures Zhongliang to acquire land, even when prices are not optimal, to maintain moderate growth. Zhongliang's attributable contracted sales are at a similar scale to that of CIFI Holdings (Group) Co. Ltd. (BB/Stable), but Zhongliang's net inventory is only 36% of that of CIFI. This narrows its headroom to weather the business cycle and explains its two-notch lower rating.
Zhongliang's land bank penetration is comparable with that of Guangzhou R&F Properties Co. Ltd. (B+/Negative), which has a much longer operating history. Zhongliang has higher consolidated leverage, including guarantees to JVs and associates, but also a stronger cash/short-term debt ratio. Zhongliang's churn rate is higher, but its EBITDA margin is lower. Zhongliang has higher non-controlling interests as a percentage of total equity, reflecting its greater reliance on minority shareholders for funding.
Zhongliang's fast-churn model resulted in a contracted sales/total debt ratio of 2.4x in 2019, one of the highest among Fitch-rated Chinese homebuilders. Its EBITDA margin is at the lower end of 'B+' rated peers and it has minimal investment-property interest coverage. The company's 2019 IPO on the Hong Kong stock exchange enhanced its financial transparency, leading to better regulatory oversight compared with unlisted 'B+' peers, such as Helenbergh China Holdings Limited (B+/Stable) and JunFa.
Zhongliang's proportionately consolidated leverage is lower than that of peers, but guarantees to JVs and associates are large relative to consolidated net debt and constrain its ratings.
KEY ASSUMPTIONS
Fitch's Key Assumptions Within Our Rating Case for the Issuer:
Land bank life of three years till 2023;
Gross floor area acquired is 1.1x-1.3x of gross floor area sold in 2020-2023;
Average selling price to rise by 17% in 2020 and 3% in 2021;
Attributable contracted sales to rise by 5% a year in 2020-2021;
Development-property cost of goods sold kept at 77% of sales in 2020-2023 (2019: 74%);
Selling, general and administrative expenses at 4.8% of contracted sales in 2020-2023 (2019: 4.8%);
Dividend payout ratio of 40% in 2020-2023 (2019: 40%).
RATING SENSITIVITIES
Factors that could, individually or collectively, lead to positive rating action/upgrade:
Proportionate consolidated leverage sustained below 40% without a large increase in guarantees to debts of JVs and associates;
Available cash/short-term debt sustained above 0.8x.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
Proportionate consolidated leverage above 40% for a sustained period;
Large increase in guarantees to debts of JVs and associates.
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
Adequate Liquidity: Zhongliang's short-term debt amounted to CNY23 billion, or 43% of total debt, at end-1H20. Liquidity, as measured by cash/short-term debt, was 0.9x. Total cash of CNY35 billion, after taking into account restricted cash, was enough to cover short-term debt by a multiple of 1.5x at end 1H20.
DATE OF RELEVANT COMMITTEE
27 July 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 RECOVERY
Zhongliang Holdings Group Company Limited
senior unsecured
LT B+ New Rating RR4
VIEW ADDITIONAL RATING DETAILS
Additional information is available on www.fitchratings.com
ZHONGLIANG HOLDINGS GROUP COMPANY LIMITED 
