(The following statement was released by the rating agency)
Nov 23 -
Summary analysis -- China Overseas Land & Investment Ltd. --------- 23-Nov-2012
CREDIT RATING: BBB/Stable/-- Country: China
Primary SIC: Real estate
Mult. CUSIP6: 169403
Credit Rating History:
Local currency Foreign currency
25-Mar-2010 BBB/-- BBB/--
12-May-2005 BBB-/-- BBB-/--
The rating on China Overseas Land & Investment Ltd. (COLI) reflects the company's established market position, geographic diversification, and its "intermediate" financial risk profile. The rating also reflects the company's consistently solid operating performances since 2005 and its good record of proactive financial management through property cycles. COLI's lack of recurring income and its exposure to the Chinese real estate market, which is cyclical and has high regulatory risks, partly offset the above strengths.
We assess COLI's business risk profile to be "satisfactory." We believe that the company will continue with its strong and consistent execution of its growth strategy. Its annual profit growth has consistently been more than 20% despite volatile property cycles. COLI, along with its associated company China Overseas Grand Oceans Group Ltd. (COGO; not rated), has projects in more than 35 cities in China. COLI is a market leader by sales in many of these cities and has good nationwide brand recognition. The company's property sales are among the most geographically diversified among its peers.
We expect COLI's sales performance to remain strong with a healthy margin, despite policy tightening. The company's property sales in the first 10 months of 2012 exceeded Hong Kong dollar (HK$) 100 billion, its revised 2012 property sales target. COLI raised the target from HK$80 billion during its interim result announcement. COLI has maintained a healthy sell-through rate of over 70% despite market volatility. The company's gross margin has been about 40% over the past three years despite the market volatility; this compares favorably with many peers. During the first half of 2012, COLI's EBITDA margin remained solid at more than 37%, partially due to its steadily decreasing ratio of selling, general, and administrative expenses to sales. The ratio, at a low 4.2%, was much better than that of most peers due to a reduction in promotional activities.
We believe COLI will maintain its financial risk profile over the next 12 months despite the ongoing market correction in the Chinese real estate sector. The company's adequate liquidity and strong financial flexibility helped it to weather the downcycles in 2008 and 2011 more effectively than its peers. In the first six months of 2012, COLI's EBITDA interest coverage remained strong at 11.0x. However, its debt-to-capital ratio was 42.7%, compared with our downgrade trigger of 45%. If we pro-rata consolidate COGO, the two ratios would change slightly to 11.3x and 43.4%, respectively.
However, after including a US$1 billion notes issuance in November 2012, COLI's debt-to-capital ratio will move closer to our downgrade trigger. COLI's leverage is likely to remain high for the rating due to its expansion strategy and increased investment in rental properties. We believe the company's good sales execution and record of disciplined financial management temper this risk. In addition, COLI's free operating cash flow has been negative for four out of the past five years due to rapid expansion.
In our base-case scenario, we have factored in sales and pre-sales of HK$100 billion in 2012. Due to good sales growth, we have assumed revenue growth of more than 30% in 2012 and about 20% in 2013, and an EBITDA margin of above 35%. We have factored in a 30% growth in total debt in 2012 and about 20% in 2013. Based on our calculation, COLI's EBITDA interest coverage is likely to remain well above 10x and its debt-to-capital ratio at 40%-45%.
The Chinese market is highly fragmented; COLI has a market share of less than 2% despite being a market leader. The company has increased its exposure in Hong Kong since 2010 and acquired several luxury low-density residential sites, which have recently generated strong sales. COLI is adopting a multi-tier-cities approach to geographical expansion. It has development interests in tier one to tier four cities, with COGO focusing on the lower-tier cities. We expect COLI to gradually expand its investment portfolio, in a manner that does not put significant pressure on its capital structure.
COLI has "adequate" liquidity, as defined in our criteria. We expect the company's sources of liquidity, including cash and available facilities, to exceed its uses by 1.2x or more over the next 12-18 months. Our liquidity assessment incorporates the following expectations and assumptions:
-- Liquidity sources include a cash balance of HK$30.3 billion as of Sept. 30, 2012, and cash flow from operations.
-- Liquidity uses include land premiums and construction spending with a total budget of HK$60 billion in 2012.
-- We expect net liquidity sources to remain positive even if EBITDA declines more than 15%.
-- COLI has sufficient headroom in its financial covenants. The company's typical bank loan covenants are not related to its EBITDA; they are mainly balance-sheet focused.
-- We believe COLI can absorb low-probability, high-impact shocks because of its good conversion of EBITDA to discretionary cash flow.
-- The company has well-established and solid relationships with banks, and a high standing in equity as well as debt capital markets.
-- It has adequate financial risk management.
We do not factor in stand-by bank facilities in China in our liquidity calculation due to their uncommitted nature. Nevertheless, these facilities do provide financial flexibility.
The stable outlook reflects our expectation that COLI will expand in a controlled manner and maintain profit growth at more than 20% annually for the next three years. We believe the company will maintain its proactive financial management and strong execution capability in China. We anticipate that gross debt will increase in line with profit and cash flow growth.
We are unlikely to upgrade COLI over the next two years given the highly cyclical nature of the industry. We may raise the rating if: (1) COLI further diversifies its product mix, such that its recurring income makes a more meaningful contribution; and (2) the company maintains its financial risk profile and disciplined financial management, including to turn cash flow positive.
We may lower the rating if COLI's financial performance becomes volatile and its financial management becomes aggressive, with more debt-funded expansion than we expect. An EBITDA interest coverage of less than 7x and a ratio of debt to capital of more than 45% on a sustainable basis would indicate such aggression.