TEXT-S&P summary: Yuzhou Properties Co. Ltd.
We expect Yuzhou to continue to improve its sales execution and product mix over the next 12 months. The company's property sales in the first 11 months of 2012 were better than we expected as it cut prices moderately and adjusted its product mix to cater more to first-time home buyers. Yuzhou's contracted sales were Chinese renminbi (RMB) 6.16 billion, exceeding the full-year target by 23.2%. The company's sales execution improved as contributions from new markets outside of Xiamen increased.
The company's low-cost land bank and its good market position in Xiamen will likely continue to support its profitability. Yuzhou's average land costs were about 15% of the contracted average selling price in the past three years. In our view, the company's operating track record, brand recognition, and the good location of its land bank in Xiamen will continue to support its above-average pricing there.
Yuzhou's profitability weakened somewhat until recently as the company expanded outside of its home market and adopted a more flexible pricing strategy. Nevertheless, we believe Yuzhou's profitability will start to recover given the company has no pressure on meeting annual property sales target. We expect Yuzhou's EBITDA margin to remain satisfactory at about 35% in the next one to two years.
We expect the company's financial performance to improve moderately in 2012. In our base-case scenario, we expect Yuzhou's 2012 credit metrics to improve as higher property sales offset lower margins, and stronger cash flows result in a more stable leverage. Our key forecast assumptions for the year are that: (1) Yuzhou's contracted sales will reach RMB5 billion, compared with RMB4.3 billion in 2011; (2) its EBITDA margins will weaken to about 35% from 42%; and (3) its borrowings will increase moderately to RMB6.5 billion to fund working capital and capital spending. As a result, we expect Yuzhou's adjusted debt-to-EBITDA ratio to be 4x and EBITDA interest coverage 3x by the end of this year.
Yuzhou's liquidity is "adequate," as defined in our criteria. We estimate that the company's liquidity sources will exceed uses by 1.2x or more in 2012. Our liquidity assessment incorporates the following expectations and assumptions:
-- Liquidity sources for 2012 include an unrestricted cash balance of RMB1.4 billion (as of Dec. 31, 2011), new loan drawdowns of RMB1.5 billion in the first half of 2012, and expected cash proceeds of RMB5.3 billion from property sales.
-- Liquidity uses include short-term debt of RMB1.3 billion, land premiums payable of RMB1.3 billion, and estimated construction costs, working capital needs, and dividend distributions of RMB4 billion.
-- We expect net sources of liquidity to remain positive even if EBITDA declines by 15%.
-- As of Dec. 31, 2011, the company was in compliance with financial covenants on its outstanding bonds and notes. In our view, Yuzhou has limited headroom to increase its offshore debt against the EBITDA interest coverage covenant of 3.0x on its US$200 million senior unsecured notes due 2015.
Yuzhou has undrawn onshore banking facilities of RMB2.9 billion (as of June 30, 2012). Nevertheless, we do not include these facilities in our liquidity assessment because they may not provide timely liquidity support. This is because loan drawdowns depend on credit availability and case-by-case approval.
The stable outlook reflects our expectation that Yuzhou will maintain satisfactory property sales and consistent financial management for the next 12 months at least. We also expect the company to have adequate liquidity while expanding outside of its home market.
We may lower the rating if Yuzhou's property sales and profitability in the next 12 months are significantly weaker than we expected or its debt-funded expansion is more aggressive than we anticipated. This may lead to a more leveraged capital structure and weaker credit metrics than we expected. We consider total debt to total capitalization of more than 60% and EBITDA interest coverage of less than 2x as indicators of such weakness.
The upside to the rating is limited until the company improves its operating scale and project diversity, and maintains satisfactory profit margins. Furthermore, we may raise the rating if Yuzhou shows financial discipline and a record of prudent expansion.