Fitch Ratings has assigned China-based homebuilder Seazen Group Limited's (SGL, BB+/Stable) proposed US dollar senior notes a 'BB+' rating.
The proposed notes are rated at the same level as SGL's senior unsecured rating because they will constitute its direct and senior unsecured obligations.
Fitch upgraded the Long-Term Foreign-Currency Issuer Default Ratings (IDR) and senior unsecured ratings of SGL and its subsidiary, Seazen Holdings Co., Ltd. (SHCL), to 'BB+' from 'BB' on 3 December 2020. The rating upgrade reflects Fitch's view that SGL's large attributable sales scale of CNY160 billion-180 billion in 2019-2020 is comparable with that of low investment-grade peers, and that it will be able to keep its leverage below 40% after dropping to 32% in 1H20. In addition, recurring rental income from the group's shopping mall portfolio has increased. We estimate recurring EBITDA/interest of 0.5x in 2020, despite the coronavirus pandemic.
We use a consolidated approach to rate SHCL, which is 67% owned by SGL, based on our Parent and Subsidiary Linkage Rating Criteria.
KEY RATING DRIVERS
Large Scale, Sales Recovering: SGL's monthly sales resumed positive yoy growth of 10% in October and 20% in November 2020, although total sales were down by 11% in 11M20 to CNY220 billion, with an average selling price (ASP) of CNY10,840/sq m. Attributable and consolidated sales accounted for around 70% and 60%, respectively, of the group's total sales.
SGL reported satisfactory moving-average cash collection of around 90% and we believe it remains on track to achieve its CNY250 billion total contracted sales target for 2020, which is 8% lower than its 2019 sales. We expect SGL to keep sales at CNY250 billion-270 billion in 2021-2022 to support its ranking as a top-20 property developer.
Lower Leverage Levels: We expect SGL's year-end leverage to remain below 40%, as we believe it is committed to controlling leverage at current levels, despite some fluctuation from land replenishment to maintain its large scale. SGL's leverage, including proportionate consolidation of joint ventures and associates, dropped to 26% in 2019, from 44% in 2018, after it suspended land acquisitions and asset disposals in 2H19. However, leverage climbed back to 32% in 1H20 and we estimate that it reached 36% in September based on SHCL's 3Q20 reporting.
SGL spent CNY69 billion on attributable land premiums in 10M20, which we estimate to be 60% of sales proceeds, up from CNY41 billion, or 25%, in 2019. It has budgeted CNY75 billion, or 40%-45% of cash collection, for land purchases in 2020-2021. Our estimates are more conservative, as we expect the company to spend 50%-55% of sales proceeds on land in the next two years, although actual land payments may be delayed and lower than publicly disclosed.
Recurring Income Supports Rating: We expect recurring income of CNY5.0 billion in 2020 and CNY8.0 billion in 2021 to boost SGL's interest coverage to 0.5x and 0.6x, respectively. We estimate that CNY2.3 billion of recurring EBITDA from CNY4.0 billion in rental and management fee income covered 0.4x of interest paid in 2019. SGL halved rents for two months in response to the pandemic, but this should be offset by expanded leasable gross floor area (LFA). SHCL's rental revenue reached CNY3.4 billion before tax in 3Q20, while LFA rose 13% from 2019 to four million sq m. SGL added 23 Wuyue Plazas in 2019 and is on track to add 30 each in 2020 and 2021.
Stabilised Operation: SGL's operational and financial risks, as well as its access to liquidity, did not deteriorate significantly after its former chairman was sentenced to gaol in June 2020. The former chairman's son, previously a non-executive director, has assumed the role of chairperson of SGL and SHCL. The former chairman no longer has a role in the group, but retains a 68% stake in SGL.
Focus on Yangtze River Delta: SGL's sales contribution was mainly from the Yangtze River Delta (YRD) and tier three and four cities and we expect the group to benefit from strong demand in YRD as well as in central and western China. The group's focus on the YRD has driven its expansion and strong sales turnover, as measured by consolidated contracted sales/gross debt, although SGL reduced its reliance on the region to 55% of contracted sales in 1H20, from 80% in 2017. SGL's successful fast-churn strategy is evident from its high sales turnover of 1.8x in 2019.
Diversified and Sufficient Land Bank: SGL had total land bank of 137 million sq m at end-1H20. We estimate its available-for-sale portion of 124 million sq m will support sales for three to four years. The group will continue to focus on YRD, but has been increasing its land bank outside the region to buffer against regional market uncertainty. YRD accounted for 46% of SGL's land bank by gross floor area at end-2019 and 44% at end-1H20. New land acquisitions in YRD still accounted for 37% of total land premium in 2019 and 56% in 1H20.
Margin Decline Credit Neutral: We expect SGL's full-year EBITDA margin, without adjusting for capitalised interest, to recover to 16%, a level similar to SHCL's 3Q20 results, after dropping to 13% in 1H20, from 21% in 2019. We think the fall was in line with industry trends. Land costs are stable, but unit construction cost rose to CNY4,147/sq m in 1H20, from CNY3,919/sq m in 2019, as more decoration costs are being embedded in construction expenses. The company also attributes the margin drop to government-imposed price ceilings to clamp down on speculative housing purchases.
DERIVATION SUMMARY
Fitch's consolidated approach to rating SGL and SHCL is based on our Parent and Subsidiary Linkage Rating Criteria due to SGL's 67% stake in SHCL. The strong strategic and operational ties are reflected by SGL representing SHCL's entire exposure to the China homebuilding business, while SGL raises offshore capital to fund the group's business expansion. The two entities share the same chairman.
SGL's quick sales churn strategy contributed to the rapid expansion of its contracted sales to a level that is higher than that of most 'BB' category peers. SGL's total sales and attributable sales reached CNY270 billion and CNY180 billion, respectively, in 2019, almost double the size of Logan Group Company Limited (BB/Stable) and China Aoyuan Group Limited (BB/Stable), while the leverage of 32% at end-1H20 is similar to Logan's 32% and Aoyuan's 35% at end-2019. SGL lowered its leverage - defined by net debt/adjusted inventory after joint ventures and associate proportionate consolidation - to 26% in 2019 due to fewer land acquisitions, but leverage increased during 2020 after land acquisitions resumed, although we estimate the company will maintain its leverage below 40%.
SGL has also rapidly expanded its investment properties, which generated CNY3.9 billion of recurring income and had recurring EBITDA/interest of 0.4x in 2019, a level higher than Sino-Ocean Group Holding Limited's (BBB-/Stable; Standalone Credit Profile (SCP): bb+) 0.3x and China Jinmao Holdings Group Limited's (BBB-/Stable; SCP: bb+) 0.2x. SGL's investment-property portfolio of around CNY66 billion at end-1H20 was much larger than that of all 'BB' rated peers, which helps justify the one-notch difference.
Compared with investment-grade peers, SGL has a much shorter track record of maintaining a stable financial profile as it aggressively expanded and built up land bank in 2016-2019. Shimao Group Holdings Limited (BBB-/Stable) had lower leverage of below 35% in 2016-2019 while also enjoying 55% CAGR growth in attributable sales to reach CNY182 billion in 2019. Shimao also has an investment-property portfolio that generates recurring income to cover 0.3x of cash interest paid.
KEY ASSUMPTIONS
Fitch's Key Assumptions Within Our Rating Case for the Issuer
total contracted sales of about CNY250 billion per year in 2020-2021 with around 70% attributable interest.
attributable land premium represents 55% and 50% of attributable sales proceeds in 2020 and 2021, respectively, based on actual attributable land premium from the company's A-share financial disclosures.
attributable property development and Wuyue Plaza construction costs equivalent to 35%-40% of attributable sales collection in 2020-2021
Investment-property revenue to reach CNY5.0 billion and CNY8.0 billion in 2020 and 2021, respectively, with a stable gross profit margin at 68%.
Overall EBITDA margin (excluding capitalised interest) to remain above 25%
SGL maintains controlling shareholding in SHCL and no weakening in the operational ties between the two entities
RATING SENSITIVITIES
For both SGL and SHCL:
Factors that could, individually or collectively, lead to positive rating action/upgrade:
Net debt/adjusted inventory (after proportionate consolidation of joint ventures) sustained below 30%
Recurring EBITDA/interest paid sustained above 0.6x
Sustained neutral to positive cash flow from operations.
Longer track record of operational and financial stability comparable with that of investment-grade peers.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
Net debt/adjusted inventory (after proportionate consolidation of joint ventures) above 40% for a sustained period
Recurring EBITDA/interest paid sustained below 0.3x
For SGL, a weakening of linkages between SGL and SHCL may lead to negative rating action.
All ratios mentioned above are based on SGL's consolidated financial data.
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: SGL had an unrestricted cash balance of CNY59.8 billion at end-1H20, sufficient to cover short-term borrowings of CNY45 billion. SHCL also had sufficient liquidity at end-September 2020, with CNY52 billion in available cash to cover CNY33 billion in short-term debt. The group's funding cost fell to 6.8% in 1H20, after temporarily climbing to 7.0% in 2H19, from 6.6% in 1H19. The company issued asset-based securities totaling CNY2.9 billion at 4.8% in early 2020, backed by four of its Wuyue malls. We expect the group to gradually monetise its malls to obtain low-cost funding.
Stable Funding Access Ensures Liquidity: The arrest of the former chairman temporarily affected the group's funding access, but it has managed to obtain financing from a large number of onshore and offshore banks since August 2019. Funding access further improved with multiple domestic and offshore issuance in 2020. The group's continued growth in contracted sales, project disposals and its decision to slow land acquisitions in 2H19 have helped maintain adequate liquidity.
The group's onshore and offshore bonds have change of control covenants, whereby the group has to make an offer to repurchase all outstanding notes if a change of control is accompanied by negative rating action, a Negative Outlook or a downgrade by an onshore rating agency for its onshore bonds or an international rating agency for its offshore bonds. The group has not breached its bond covenants since the former chairperson's arrest.
DATE OF RELEVANT COMMITTEE
03 December 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.
SEAZEN GROUP LIMITED 
